Hedging Lessons options

CBOE’s VIX Tail Risk Hedge Strategy (Advanced Options-Based)

After a massive V-bounce since the Christmas Eve massacre, some of the more advanced readers here may be considering taking some profits off the table or adding some downside hedging. Side note, pardon the fact we haven’t done almost anything on this level as of yet. We’re hoping to get beginners catching up so we can start the “fun” stuff. Anywhoooo, 1-Month returns tends to have a short term reversion, so right now is the perfect time for adding a hedge. The following is a strategy that most have never heard of courtesy of the CBOE. Execution is simple assuming that you have the ability to purchase VIX options. 

CBOE Tail Hedge Strategy


1. Review the current level of the VIX. Right now, we’re sitting at 15.74

2. Depending on the VIX level use the following table to figure out how much of your portfolio will be allocated to this hedge.

So in this case, even though its just by a hair, we’d go with the 1% allocation with the VIX between 15-30. For the sake of simplicity, we’re going to assume a portfolio size of $100k. So 1% = $1,000 to be used for the hedge purchase.

3. You will use the forward month of the VIX option table, and find the call option sitting closest to 30 Delta. Currently, that for the forward month of 13 Feb 19, the closest is going to be the $17 strike sitting at 31 Delta.

4. The Feb 13 19 $17 call currently has a mid of .85. So with $1K, that’s going to be $1K/$85 = 11 calls. That’s it. Just let it ride to expiration.

5. If you’re new to VIX options, keep in mind that they have European Style cash settlements. Meaning your ITM calls will settle in cash and can ONLY settle on the date of expiration. The call we bought in the above example only has 8 days left to expiration. If you’re in the money, it will settle as cash. If the market plummets, that cash value will skyrocket.

6. The day after expiration, you will start again from step 1 and review where the VIX is sitting by that time. 

Easy enough, and back tested results are phenomenal (and the best CBOE tested strategy). If you’re interested in reading a bit more on the testing, see the links below.




Further Reading:

Portfolio Hedging using VIX Calls (TheOptionsGuide)

Buying VIX Calls As A Portfolio Hedge (JimFink)

Cboe VIX Tail Hedge Index (VXTH)

Settlement Information for VIX Derivatives

Key Tools for Hedging and Tail Risk Management PDF- CBOE

^^Essential Download for your hedging library.

Options- and Volatility-Based Strategy Benchmark Indexes A few CBOE alternatives