Question

Cboe Volatility Index (commonly referred to as VIX) is a measure of volatility published by Chicago Board Options Exchange. It is also commonly known as the fear index as it measures how volatile the stock price movements are. 4 When times are good and stable, its values are low. But when the market experiences swings, VIX value increases. A number of derivatives (such as S&P 500 VIX Short-Term Futures) were developed; they are designed to profit on either low or high VIX values. Investors can supplement their stock portfolio with VIX futures and receive reimbursements if the volatility increases. On the other hand, they can also take the opposite position and profit from stability on the market. 1) Demonstrate how VIX futures work. 2) Critically evaluate how risk can be hedged using VIX futures and, on the other hand, what risks such a strategy can bring. 3) Analyse how the VIX index performed since the start of the COVID19 pandemic and explain why.

Answer 1

VIX futures allow investors to speculate on future market volatility. Hedging with VIX futures involves offsetting potential losses in a portfolio. The VIX index experienced significant fluctuations during the COVID-19 pandemic.

Step-by-step explanation:

VIX futures are financial instruments that allow investors to speculate on the future volatility of the stock market. These futures contracts are based on the VIX index, which measures the expected volatility of the market. Investors can take positions on whether they believe volatility will increase or decrease in the future.

Hedging using VIX futures involves taking a position that offsets the potential losses in a portfolio. For example, if an investor owns stocks and wants to protect against a market downturn, they can buy VIX futures to potentially profit if the market becomes more volatile. However, this strategy comes with risks, such as the potential for the VIX index to not move as expected or for the market to experience sudden and extreme volatility.

Since the start of the COVID-19 pandemic, the VIX index has experienced significant fluctuations. In February and March 2020, as the pandemic spread and caused uncertainty in the market, the VIX index reached all-time highs. This was due to the heightened fear and volatility in the stock market. However, as the market stabilized and recovered, the VIX index gradually decreased.