Be Careful Not To Overdo Your Hedges

One thing that you never want to do with any protective strategies is expose yourself to even more risk through your hedges. This may sound simplistic and obvious, but it is not.

I once discussed the use of VIX options as a hedge against a short volatility position in the form of short S&P 500 calls and puts. This can be a great place to use the VIX, as there is a direct relationship between the index and SPX volatility.

But what if you just want to sell puts in the VIX? That was once suggested by an acquaintance of mine who is a Ph.D risk director for a hedge fund.

It is true that those VIX puts would lose money if the S&P 500 fell and the VIX rose, creating a profit for the “hedge.” However, the real concern for a short volatility position is the proverbial “fat tail” or “black swan” in which there is huge drop in the S&P 500 and a corresponding spike in the VIX, as we saw in 2008.

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