Tactical Asset Allocation with VIX Futures

The study starts with an extensive description of the characteristics of the VIX, VIX Futures and their relation to the S&P 500. This study examines the impact that the addition of VIX Futures to the opportunity set has for an average US investor. The ex-post results indicate that adding VIX Futures to various types of portfolios yield significant diversification benefits for a risk-averse US investor. Besides using traditional performance measures, the study includes an investor’s preference for positive skewness and low kurtosis. It is shown that it is ex-post optimal to include a small long VIX Futures position during 2005-2011. Also the prospective analysis suggests including a long VIX Futures position for the near future. Several dynamic trading strategies are examined which indicate that the VIX index can be used as a stock market indicator under certain circumstances. A ‘timing with VIX Futures’ trading strategy that uses the VIX index as a crisis identifier yields a very favourable risk-return relation. Overall, the unique risk & return characteristics of VIX Futures combined with the strong negative correlation between VIX Futures and the traditional asset classes indicate that VIX Futures function as a very interesting diversification vehicle. The goal of the study is not to provide a specific investment strategy recommendation for the average US investor; the goal of the study is to encourage investors to consider having VIX exposure. It is shown that a long VIX Futures position creates significant diversification opportunities, especially during bearish market environments.