CHICAGO (Reuters) – Once again, “fiscal cliff” mayhem has given investors a furtive look into the unsettling world of market volatility, which will not end with Tuesday’s deal. We will likely see more Tilt-A-Whirl politics in the coming two months as Congress deals with the debt ceiling and budget cuts.
Volatility has long been the enemy of the mainstream investor. It is easy enough to measure and hedge, but short-term gauges and volatility products such as exchange-traded notes can get you into trouble. They do not work effectively for buy-and-hold investors and have to be timed precisely for traders.
The skittish mass psychology of 2011 set the stage nicely for exchange-traded products that track or blunt volatility. After a rough summer of debt-ceiling and euro zone gyrations, the S&P 500 barely eked out a gain.
Despite the S&P 500 index’s rebound of some 13 percent in 2012, investors yanked more than $150 billion from stock funds during the year. This anxiety propelled sales of more than a half-dozen low-volatility stock and index funds.
The most direct way of addressing volatility is to invest in an index that tracks it. The VIX index from the Chicago Board Options Exchange is one of the most popular, and several exchange-traded vehicles are linked to it. The index tracks “implied volatility” and near-term expectations through S&P 500 index option prices. Generally, it is an inverse gauge to the S&P. When the big-stock index is down, the VIX is up, so it can act as a hedge against major stock sell-offs.