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Volatility Index Essay

570 words - 3 pages

Exploiting Volatility
In the times of recession and variability with the market getting volatile with very far glimpse of normalcy being stored, it would not be a good suggestion to just sit and watch rather it would be a better strategy to make ways to scale up the investment by learning to exploit volatility by diversifying asset allocation, rebalancing portfolio and option strategies. High return volatility definitely increases the fluctuation of the asset class weightings around the target allocation and increases the risk of significant deviation from the target but greater volatility also results in compounded returns . It is substantiated by the situation when the government is spending trillions of dollars to stimulate the growth in the economy and the corporate world is moving ahead with aggressive restructuring.
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This approach requires selling stock when the price goes up and investing the proceeds to buy something that has gone down. Though it is difficult being against human instincts but can amass huge amount of money. Rebalancing is not merely related to momentum and reversal but it also leads to outperformance over the long period. It is true that sometimes an investment has 30% return and the next year it may be as low as -10% and the may rise back to 30% or more and so on. But if we see the arithmatic his period it comes out to be positive through out hence rebalancing not only helped reduce loss but also helped us in achieving a high over all growth rate for the portfolio. This was because the two assets selected in the portfolio had 0 correlation which lowers the volatility. This benefit is also called capturing volatility in stochastic portfolio.
If we compare the returns of a rebalanced portfolio with a buy and hold strategy, the returns of a rebalanced portfolio is higher for various levels of volatility. The rebalancing premium is highest when correlation is low and volatility is high and the premium is lowest when correlation is highest and volatility is low. In the latter situation the buy and hold can be a better strategy.
Another important way to cope with volatility is by hedging and leveraging with call and put options. In such situations where the clients are ready bear 10% volatility but not 30%, it would be a good strategy to combine long put options and short call options and make up a portfolio with 10% volatility. Over the past 10 years such portfolios had significantly higher risk-adjusted returns than the most outperformance index during 2001-08. Moreover the premiums from the sale of the call options can be used to offset the price of the put options constructed. The leveraged ETFs also help fight volatility.

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