Monetizing Volatility in the Nasdaq-100 Index®
Securities prices move up and down intraday and over longer periods, and how fast they move is known as volatility. Investors ideally monetize volatility by taking advantage of opportunities to buy low and sell high. But at the same time, volatility goes hand in hand with risk: when it’s high, an adverse move can result in losses that are too big in relation to the portfolio. Now an innovative mutual fund, Equity Armor Investments’ EAVOL Nasdaq-100 Volatility Hedged Fund™, offers a unique strategy for investors to manage volatility risk and leverage it for long-term capital appreciation.
Equity Armor Investments’ founders – Brian Stutland, Luke Rahbari, and Joe Tigay – were pit traders and early adopters of the CBOE Volatility Index® (VIX), which generates a 30-day forward projection of volatility. The VIX is a way to gauge market sentiment, so some call it “the fear index.” Before long, the team became the largest electronic market makers of VIX options at a time when the index’s popularity was second only to the S&P 500 (SPX).
“We identified a knowledge gap between experienced traders and financial advisors who wanted to hedge for their clients,” says Joe Tigay, Chief Trading Officer and Portfolio Manager, Equity Armor Investments. “In 2011, we forged Equity Armor Investments into an advisory firm and began to develop strategies for financial advisors and their clients who wish to monetize volatility.”
In October 2020, the firm took over the EAVOL Nasdaq 100 Volatility Hedged Fund (CLPAX™, CLPCX™ and CLPFX™), a mutual fund that complements Nasdaq-100 Index® (NDX®) securities with a distinct volatility hedge overlay.
Here’s how it works. The fund invests at least 80% of its net assets, plus the amount of borrowings for investment purposes, in equity securities that constitute the NDX. It invests in most of the companies comprising the NDX in near proportion to the weightings in the index. It also invests in ETFs and ETNs that track the NDX as well as futures and options on the index.
Then the fund hedges most of the NDX risk by investing up to 20% of its assets in VIX futures contracts expiring in two- months at the time of purchase as well as options on VIX futures. The VIX is constructed using the implied volatilities on SPX options, so the fund implements a beta correction to ensure that it doesn’t have an unwanted SPX exposure. The fund monitors Nasdaq-100 Volatility Index Futures® and other indexes as a price gauge and to gain insight into market sentiment.1 In addition, it invests in cash and cash equivalents, including U.S. Treasury obligations, as a volatility overlay.
“In my experience as a market maker in volatility, many investors think that volatility will keep going up to infinity, or equities will go to zero,” says Tigay. “But I assume when equity prices fall, it’s a good time to buy them because they’ll go back up. Moreover, when volatility spikes, signaling fear in the market, that’s a good time to reduce your hedge.”
Some investors are reluctant to invest in the NDX because of its volatility characteristics. But the EAVOL Nasdaq 100 Volatility Hedged Fund provides investors with an opportunity to participate in the upside of the NDX and still control their risk. It could fit into their portfolio as an alternative equity strategy designed to produce a blended equity return.
Before investing, Tigay recommends that financial advisors and investors should understand how the EAVOL Nasdaq 100 Volatility Hedged Fund is different from other hedged equity strategies.
“Most hedged equities strategies make their hedge component cheaper by selling options around the long option that they own, but that exposes them to downside risk and caps the upside,” explains Tigay. “We make it cheaper through back-and-forth trading. When volatility goes up, we sell it. Our goal is to preserve investors’ equity returns and have less downside.”
They should also understand when the fund will likely have periods of outperformance or drag.
Essentially, the EAVOL trading strategy may appreciate during times of downward equity prices or when market forecasts expect movement in equity prices. Similarly, when equity prices appreciate or when the market doesn’t expect movement in equity prices, the EAVOL trading strategy is likely to decline in value.
The volatility overlay aims to minimize possible losses that are common in stock indexes so that investors might be able to ride out market swings in pursuit of their long-term investment objectives. However, the volatility overlay has an associated cost. If the NDX rises for a long period of time, the fund may never show any gains.
NDX includes many of the top U.S. growth companies, and Tigay believes it’s the future of the economy. He thinks the best strategy is to invest in the companies in the index through the mutual fund and have protection at the same time.
1. The Nasdaq-100 Volatility Index™ (VOLQ™) measures changes in 30-day implied volatility of the NDX. To learn more about what to look for when analyzing the Nasdaq Volatility Index VOLQ relative to VIX, please visit https://www.nasdaq.com/videos/what-to-look-for-when-analyzing-the-nasdaq-volatility-index-volq-relative-to-vix.-100.
Nasdaq®, Nasdaq-100 Index®, Nasdaq-100®, NDX®, Nasdaq-100 Volatility Index™ and VOLQ™ are trademarks of Nasdaq, Inc. The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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