Saturday, February 11, 2017

The Index ETF Beating Nvidia

You may not have noticed but there is actually a non-leveraged index ETF that has been outperforming Nvidia over the past three months.  If you've never thought about selling the Volatility Index $VIX then you may want to think again.  Since November, Velocityshares Inverse Volatility ETF $XIV is up over 60% while $NVDA is up only 30%.  I know what you're thinking...selling volatility is dangerous...and you'd be correct in that statement with a few important exceptions.

Investments are only dangerous when you over-do them

An investment in inverse volatility can be a valuable income producing component to any well balanced diversified portfolio.  Since $VIX is correlated with the emotional sentiment embedded in the market a short position will outperform the S&P 500 $SPY when sentiment is positive and underperform when sentiment is negative.  The key to being successful with this investment is keeping it a small component of your overall portfolio.  You'll also want to add to this investment when fear is overwhelming investors and subtract when greed is doing the same.

It is natural for market volatility to depreciate over time

If the best assets to buy are things that appreciate over time like stocks, bonds and real estate then shouldn't the best assets to sell be things that depreciate over time?  Think about it, why shouldn't volatility persistently decrease over time?  People continuously create, invent, and imagine new technologies that remove uncertainty in the world.  We have the resiliency and the resolve to work through difficult problems, learn from our mistakes and come out stronger on the other end.  The free market mechanism itself is designed to achieve efficient price discovery which is all about eliminating volatility and uncertainty.  Think about building a long term investment in the idea that fear and uncertainty generally subside over time.

Do the Contango

I'll be honest, whenever I read the word contango I think of the Argentinian dance and it'll always be that way, so terrible word but great concept.  Contango is usually present in commodity markets like crude oil or corn because the price you pay for some commodity has to embed all of the costs of storage which can sometimes be very steep.  This is why it is so hard to make money buying and holding crude because all those storage costs will eat your investment alive.  The financial mechanics of how your investment becomes dinner is complex but has to do with the pricing of futures contracts so any investment that holds futures will usually suffer from this decay.

Selling volatility also involves the use of futures contracts but since you are selling rather than buying, those storage costs tend to benefit you rather than hurt you.  In fact, inverse volatility is the only asset that I know of that naturally appreciates and also pays storage costs; please tell me if you know of another one!  Why should other people pay you to hold this naturally appreciating asset?  I think that it has something to do with the persistency of fear embedded in financial markets.  The nature of risk is complex and can be a double-edged sword at times so don't try anything that makes you uncomfortable.  Take some time to read more about market volatility and when you're ready start small. always...don't over do it, stay diversified and think long term.