So…Now What? Did I miss the Opportunity for Tail Risk Protection?

We’ve been telling anyone who would listen to properly diversify into something that actually does well in a market crash (like, here, and here, and here). Something with dynamic investment strategies that react to paradigm shifts and get on board with them. Things that do well in volatility spikes, but also when the spikes don’t happen. Investments that are setup for the Black Swan, but fine with the market going back to all time highs as well. Antifragile alternative investments like the newly launched Mutiny program spreading risk across multiple volatility traders putting on various types of convexity trades designed to not just make money when markets go down, but at an increasing pace. What we’ll collectively call throughout this post = long volatility.

That’s all well and good, and many of our clients listened and had such long volatility protection during the recent market crash, which, by the way, we still don’t have a clever name for yet. CoronaCrash? Coronapocalypse? Covid-Crisis? Pandemic Panic? But what about all those who didn’t have any tail risk protection, and now see the need for it quite clearly? We can’t go back in time and properly diversify. And while knowing that it’s only prudent to protect against future crashes; that little voice in our head seems to keep asking….

BUT…. Did you miss it? 


This has quickly become the overwhelming question we’ve been getting. Some mixture of the simplistic question in the gif above and more nuanced ask:

If tail risk, positive skew, and convexity type programs that benefit from spikes in volatility….have just benefitted from the mother of all spikes in volatility…. Is now a good time to get in those?

Not an easy answer to be sure. This isn’t Tesla stock and the fear of missing out on ever higher prices. (FOMO as it’s known on FinTwit). This is the Fear of Already Missed It (FOAM?).

But what does that question really mean? What are people really asking when they ask if it’s too late for long volatility protection. It usually boils down to some combination of the following fear factors, which we’ll cover one at a time:

      1. Is it more risky now than before?
      2. Is there less upside now than before?
      3. Did it lose some of its protective powers?


This is the most human of the questions, hitting on our inner behavioral biases and fears. Everything is scary right now. Indeed, we’ve just seen supposedly “safe” investments like blue chip stocks and corporate bonds, and even treasury bonds on some of the days during this crash, get wrecked.

So, should I also be scared of the exposure long volatility programs can provide? Asked another way, if a long volatility program just reeled off +20%, +30%, +40% while the market was down week after week; can it turn around and lose that much or more when the market rallies back?

The quick answer to this is – not very easily and not very likely. You see, long volatility programs don’t make gains in big market sell offs by levering up portfolios and betting on red numbers. This isn’t make 20% if equity markets fall, lose -20% if they rally. No, they mostly do it structurally, setting up asymmetric risk/reward trades that payoff either when markets fall or volatility spikes – or both.

A very simplistic example is selling e-mini futures each time the market breaks below a 21 period (hr/day/week) low, and risking 0.50% of the account on the trade. Should the market break significantly lower, the trade could make 2%, 3%, 5% or more on the trade? If the market doesn’t see follow through to the downside after triggering a trade and rallies back, the trade loses up to -0.50% of equity. That’s asymmetry – heads you win 5%, tails you lose -0.50%.

What’s more, long volatility programs have convex return profiles – where the amount of money made increases non-linearly as prices go the trade’s way.  That convex return profile also means the potential loss on each trade, is – by design – at the smallest part of that curve. This an option buyer’s profile, versus an option seller’s profile where the largest part of the curve is the potential loss.

But…you might be saying, aren’t those options more expensive now than they were before… indeed, which brings us to the question #2.


To think about this very simply… if long vol is buying the VIX at 12 in case it goes up to 30 or 50 or 70… then what chance do we have if the VIX is already at 60?  Does it have to go to 100 for the same return profile.  Further, if long volatility programs are essentially buying volatility, and volatility proceeds to decrease over the next 6 to 18 to 24 months, what does that do to that inherent buyer’s profile. It seems like it wouldn’t help.

This is the most real of the concerns, to be sure, as there is a practical limit to how high volatility can go, and perhaps more importantly, how long it can stay there. Take 2008 as an example, where volatility per the VIX peaked in October of 2008, but the US market via the S&P didn’t post a low until March of 2009.  What happens to long volatility strategies when the volatility stops going up… but the market keeps going down.

Well, it’s worth noting here that the CBOE Eurekahedge Long Volatilty Index of “hedge fund managers who take a net long view on implied volatility with a goal of positive absolute return” returned 14.2% over that five month volatility down/stocks down period. AFTER returning 30% from October 2007 to October 2008 as the financial crisis gained steam and volatility exploded. What’s more, from the March 2009 low to the new highs for US stocks in March of 2013, the long volatility index returned 28%.

[Past Performance is Not Necessarily Indicative of Future Results]

Source: YCharts, EurekaHedge. S&P = SPY ETF, EKLV = Eurekahedge CBOE Long Volatility Index

Interestingly, the past data shows you’re better off worrying about less upside when the VIX is at all time lows than when it is at all time highs. The past data per this index shows that it isn’t high and declining volatility that spells trouble for this type of alternative investment strategy. It is low and stagnant volatility. Per the numbers – VIX in the 20s, 30s, 40s and beyond tended to be good environments, while VIX in the teens tended to be bad environments.

Why is this so?  Because volatility clusters. It isn’t a shooting star as much as a passing comet, visible in the night sky for an extended period of time. As Wayne Himmelsein of Logica Capital put it in more mathematical terms:

The mathematical defense, to an extent, is that “vol clusters”.  One big point here is that the whole reason the large world of vol traders utilize an ARCH (or GARCH) model to model volatility is precisely because of this “sticky” affect.  ARCH is AR “Autoregressive” and CH “Conditional Heteroskedasticity” – where autoregressive implies that future values rely on previous values, and the conditionality of heteroskedastic implies that increasing vol begets increased vol!  So the math, quite literally, implies feedback loop.

Said another way, higher vol (even if it is decreasing from all time highs) leads to more higher vol (although perhaps not quite as high), reminding us of a sort of nuclear half life. The Vol spikes imprint the ‘radioactive’ material on the markets, which don’t easily get shaken off. There is a half life to that vol which tends to be longer and more pronounced than one would think.

This clustering (or radioactive decay, if you will) leads to an environment that when vol is very low, like 12 to 15 low, there’s only one game in town really, which is waiting for a big spike. And when vol is high, opportunities abound: You can capture the difference between overpriced sections of the volatility curve relative to other parts of the curve. You can capture upwards volatility spikes withing the general downturn in volatility. You can capture the decay in volatility while keeping the exposure to spikes (via being short front month VIX futures and long back month futures, or short VIX and short ES futures as a hedge).

In plain speak, all of that is to say that there are two sides to the long volatility trade.

      1. The common sense idea that you buy volatility cheap (like VIX in the teens) and sell it dear (like VIX in the 50s).
      2. The more nuanced idea that VIX in the 20s, 30s, and above represents a target rich environment for adept vol traders who can take advantage of relative mispricings between volatility instruments.


Which brings us to the highly related, but somewhat different, question of whether investing in a long volatility program now when volatility is high in some way diminishes its diversifying abilities. This is similar to asking if there is less opportunity, but looked at less from a desire to profit and more from a desire to protect the other parts of one’s portfolio.

We’ll let Black Swan author Nassim Taleb give the short answer here:

The worst thing you can do with insurance is try to time it,” Taleb, a distinguished professor of risk engineering at New York University, said in an interview Monday on Bloomberg Television ( “If you don’t have tail insurance, you don’t have a portfolio. Your portfolio is going to blow up.

The more involved answers reminds us of the old investment/math joke, that the market can go down -50% every day and you’ll never get to zero. Which is to say, there’s no magic number limiting how far stocks can fall. Just because we’ve sold off more than -30% doesn’t mean we can’t sell off another -30%. Stocks fell -56% in the financial crisis. They fell -90% in the Great Depression.

Long volatility managers know these stats like the back of their hand. They know the probability of similar market losses happening in the future is small, yet not zero.  And they know analysis like that of Rusty Guinn on Epsilon Theory below showing we’re likely very, very far from having any idea how this whole pandemic and resulting Global shutdown shakes out:

…how long until [your average local restaurant]… have to stop paying the waitstaff and line cooks? How long until the credit line…runs dry or gets pulled? When they stop paying rent, how long until the local businessman who owns their building is forced to pull capital earmarked to fund the growth of his valve-fitting shop to service the debt he used to buy it? How does that impact the growth and returns of the small factory in the region that had counted on their order being delivered on time?

And how long do these types of effects ripple through multiple businesses and multiple industries?

What happens to consumer behaviors after a month or two of social distancing? After a month or two of adapting to a life without available daycare? After a month of effectively homeschooling children? Is there a tranche of the public that remained loyal to local brick-and-mortar retail for some category of their consumption that will undergo a permanent transition to online shopping? Do consumption patterns change permanently in other ways?

And what of tourism? How long do tourists eschew Covid-19 hotspots? Cruise ships? Casinos? Ride-sharing? Will ALL the fashion and real estate and investment conferences…come back in 2021? How long will the overhang on tourism more generally last? …how long can those industries hang on before capital flees to other endeavors, domestic or otherwise?

If and when we flatten the curve, and Covid-20 pops up in the winter, how reflexively and violently do briefly allayed fears shift behaviors back to the state we know today?

…you are sitting in your home office in the middle of a pandemic quarantine…But you are also sitting in the middle of a period of historic change and upheaval. Do you think that it is possible that an almost complete shut-down of many forms of trade, tourism, travel, retail activity for 1-2 quarters or MORE will not result in some kind of transformation? Of consumer behaviors? Of regional industry? Of local industry? Of investor preferences? Of the shape of globalization?

Take off the blinders and LOOK.

Of course, that’s all narrative that most long volatility managers don’t subscribe to, being systematic in their approach to markets. They aren’t putting on more long volatility exposure because of so many unknowns being talked about. They are keeping on long volatility exposure because they know the only mathematical certainty in markets is that the future is unknown, and that market participants till attempt to price that uncertainty via volatility instruments. In short, there’s no vol spike that would change the minds of long volatility managers to suddenly believe that all of the uncertainty in markets is currently reflected and there’s no need to protect against further uncertainty. Their models are designed to protect and profit from that uncertainty, whether it be from the calmest of times or the most stressful of time.

What’s more, they know their investors will be upset if they grab quick profits during a volatility spike only to see the selloff keep going. That’s one of the reasons why long volatility managers, on the whole, always maintain a positive skew (think option buyer profile) in their individual trades and overall portfolio. They don’t want to be the one long vol manager at the industry conference who got out at -10% when the market went down -40%.

Of course, there are some who focus just on the quick first legs of a move. There are some that focus on the large moves like we’ve seen during the pandemic and 2008. And there are some who look to participate in both. And this does create some path dependency risk for investors in long volatility programs – not because the protection abilities are less after a vol spike, but because certain managers are only designed to capture certain parts of the spike. The solution to that = an ensemble approach across different managers to insure each path dependency is covered.


The big thing we haven’t covered here is what an investment in a long volatility program at these levels (after the vol spike, when you feel like you may have ‘missed it’) means for your overall investing psyche.

In short, the question you should be asking isn’t whether you’ve missed it, but whether such an investment in long volatility will help you not miss the bigger “IT”. That “IT” being the eventual rally back in your short volatility investments in the stock market, real estate, venture, and more. The question you need to be asking is what can a long volatility investment do to my psyche in order to get me back in the overall market sooner.

Indeed, the bigger power of the exposure and past performance of the long volatility index highlighted earlier wasn’t the 28% returns in the vol investment. No, the power was having that protection to allow you to get back into the market at a much earlier point, knowing you had coverage should we keep going down. Its power was its ability to let you not miss out on a quick 100% spike in equities, what some called the most hated rally in market’s history because of the lack of general participation due to fear that the worst wasn’t over.

Who knows if market keep going lower, snap back higher, or something in between…  Nobody. But long volatility investments that help protect against the downside, paired with owning stocks, real estate, and more help you say… Who Cares? I’m covered!

– Jeff Malec

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