On the surface, the stock market has rebounded a lot since the beginning of this year. However, looking beneath the surface, it is not a broad-based recovery. Only a handful of stocks account for most of the S&P 500 gains this year. And most of these stocks are riding on the back of the same AI wave. This is why the Nasdaq is the leading index this year, up more than 20%.
Other asset classes are also starting to lose steam after a good start to the year. In such an environment, a typical balanced portfolio comprising stocks, bonds, and commodities would find itself going nowhere. This is where the unique volatility asset class comes in. We teach a volatility trading strategy as part of our education offering. Below is the performance of this strategy since the start of 2022.
The S&P 500 did make good progress this year, but it is still underwater and nursing losses incurred in the prior year. Our volatility trading strategy, on the other hand, not only ended the year up in 2022 but also proceeded to make new highs this year in 2023 weathering through the regional bank crisis and the recent debt ceiling talks. Our model achieved this by positioning itself on the right side of the volatility trade and in particular this year, it has maintained the shorts and did well.
Weakness Of Volatility Trading
The temptation to trade volatility as a stand-alone strategy can be irresistible, given the potential to earn good profits like this year. However, this is not something we recommend because of a few factors.
Lack Of Liquidity
Volatility ETFs are a relatively new invention. The AUM gathered by these ETFs is not high compared to traditional ETFs like SPY or TLT. The biggest volatility ETF VXX only has about USD300m AUM. The SPY ETF has close to USD400b AUM. VXX can absorb the volume of a small retail trader, but the danger is that if many people are using the same strategy and trading at the same time, liquidity can become an issue. There is no way of knowing where the tipping point is. One alternative is to trade VIX futures directly, but that requires rolling the futures near expiry, and it would not track the ETF movement exactly.
Highly Volatile Strategy
Volatility trading is by nature highly volatile. It is the most volatile strategy that we teach.
You might not appreciate how volatility can affect you because it is less intuitive than returns. But think of it this way, imagine the strategy losing 30% in a single day before rebounding the next day. And it happens not just once but numerous times. This will have a drastic impact on our psyche and makes it hard to sleep at night. We might also bail at the wrong time.
Risk Of A Black Swan Event
All asset classes have their own share of tail risks. But VIX does have a greater propensity for huge movements compared to other traditional asset classes. It can spike more than 100% in a single day. Such moves are not uncommon among single stocks, but you probably don't see it happening to other broad asset classes. Now when that happens, short-volatility ETFs can collapse and prices drop near to zero. And this was exactly what happened during the famous Volmageddon event in Feb 2018. While this is an isolated event across the 14-year history since VIX-based ETFs were launched, and issuers have taken steps to lower the chance of a repeat incident, we can never rule out the possibility of such an event recurring.
Volatility Trading As A Powerful Addition
The real potential of volatility trading is when used in combination with other assets or strategies. Through diversification, the weakness of volatility trading can be mitigated. That is why volatility trading is a key component of the various portfolio solutions that can be accessed through a working arrangement we have with Ou Da Wei, a senior investment adviser with iFAST GM (Singapore). On top of mitigation through diversification, the volatility trading strategy that he runs for clients is an advanced version that reduces the risk further and yet generates significantly higher returns. When we pair it up with high-quality safe-haven assets such as government or quasi-government bonds, it allows the possibility to structure portfolios with an element of protection in the current market environment.
A summary of the portfolio solutions is presented below.
Find out ways you can invest through a coffee session!
AllQuant brings to the table a new solution for busy professionals. We put all our 30 years of joint experience across asset management, banking, proprietary trading, and hedge fund to work. And we designed an actively managed multi-strategy model portfolio that is resilient enough to weather different market conditions.
You can now build such a portfolio through iFAST Global Markets without lifting a finger. In this collaboration, we are combining AllQuant’s expertise in hedge fund strategies and iFAST’s advisory capabilities and bringing it to your doorstep.
Ready to start your investment journey? Chat with us over a cup of coffee through a session facilitated by iFAST Senior Investment Adviser, Ou Da Wei, to find out more.
Disclaimer & Disclosure
We are not financial advisers or fund managers. The information published on this Site is provided for informational purposes only. It is not intended to be, nor shall it be construed as, financial advice, an offer, or a solicitation of an offer, to buy or sell an interest in any investment product. Nothing on this site constitutes accounting, regulatory, tax, or other advice.
Any performance shown on this Site is model performance and is not necessarily indicative nor a guarantee of future performance. You should make your own assessment of the relevance, accuracy, and adequacy of the information contained on this Site and consult your independent advisers where necessary.
AllQuant is carrying out introducing activities for iFAST Global Markets (Singapore) as an independent entity and is NOT an agent, servant, employee, representative, or in partnership with iFAST Global Markets (Singapore). AllQuant will be receiving remuneration or introducing fees from iFAST Global Markets (Singapore).