Volatility as an asset class: how VIX products behave and when they diversify

Volatility products offer exposure to the implied volatility of equity markets—specifically the market's expectation of future realised volatility as priced into options. The most widely followed volatility index is the CBOE Volatility Index (VIX), which measures 30-day implied volatility on the S&P 500. Despite being commonly described as the fear gauge, the VIX is not directly investable. Actual volatility exposure is obtained through volatility futures, exchange-traded products (ETPs) that track VIX futures indices, or options strategies. Each has a different return profile, and almost all long volatility products are subject to a structural cost that erodes returns over time.

The VIX: a price, not an asset

The VIX index represents the annualised implied volatility derived from S&P 500 index options. It reflects what options market participants are paying for protection against near-term equity moves. Key properties:

• The VIX tends to spike during equity market stress—March 2020 peak: 85; October 2008 peak: 80—and declines during calm markets
• The long-run average VIX level is approximately 19–20
• The VIX is mean-reverting and cannot sustain extreme levels for extended periods
• Holding the VIX as a portfolio asset would provide a near-perfect equity hedge—but the VIX is a price, not a tradeable asset; no instrument tracks the spot VIX level

VIX futures and the term structure cost

VIX futures allow investors to take a position on where the VIX will be at a future expiry date. The VIX futures term structure is almost always in contango—futures prices above the current spot VIX—because:

• The VIX is mean-reverting; after a volatility spike, the market expects volatility to fall, so near-term futures trade at a premium to the current elevated spot level
• In calm conditions, investors pay a premium for future volatility protection, pricing in an expected volatility that is higher than the prevailing calm implies

Products such as the iPath VXX ETP roll VIX futures monthly. In calm markets, this roll cost has historically amounted to 5–10% per month of negative roll yield. Over a full year without a major volatility event, a long VIX ETP can lose 50–70% of its value from roll costs alone.

Volatility as a hedge vs as a long-term holding

The asymmetry between tactical hedge value and long-term holding cost is stark:

• Short-term hedge: a small allocation to long volatility products can offset large equity losses during a crisis. In March 2020, VXX rose approximately 160% as equities fell 34%; a modest VXX allocation could have offset a significant fraction of equity portfolio losses
• Long-term holding: the roll cost makes a permanent long volatility allocation a costly drag; between major volatility events, the position consistently loses value

The practical implication is that a permanent long volatility allocation is a poor long-term strategy. Short volatility strategies—selling options or holding inverse VIX products—earn the roll premium but expose the portfolio to potentially large losses in a volatility spike, as the events of February 2018 (XIV termination) demonstrated.

Volatility products in practice

Common instruments for volatility exposure include:

• VXX / UVXY: long VIX futures ETPs on US exchanges
• SVXY: short VIX futures ETP (inverse exposure); earns roll premium but has large left-tail risk
• Options strategies: buying put options or straddles provides more precise and time-limited protection but requires active management

Most of these instruments are complex, involve leverage or path-dependency, and are appropriate only for investors with a specific, defined risk management objective.

Limitations

• Roll costs make long-term long volatility allocation economically unfeasible in most market environments
• Volatility spikes are unpredictable; timing a volatility allocation is extremely difficult
• Inverse and leveraged VIX products carry daily reset characteristics that create long-term performance drag distinct from the underlying index
• Regulatory restrictions: some VIX ETPs are unavailable in certain jurisdictions, particularly within the EU under PRIIPs regulations

Volatility products in pfolio

pfolio supports volatility ETP positions within the portfolio analytics framework. Users who hold VIX-linked products can track their total return, roll cost contribution, and correlation to the rest of the portfolio. Given the structural cost of long volatility, pfolio's analytics make the carry cost visible, helping users assess whether the hedge value of a position justifies its long-run drag.

Related articles

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• Volatility in investing: how to measure and manage portfolio risk
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• Leveraged and inverse ETFs: how they work, what they cost, and how pfolio uses them