How can investors hedge their risks? Should I choose VIX call options or S&P 500 put options?

In terms of hedging, should investors choose VIX call options or S&P 500 put options? As the peak of the Chicago Board Options Exchange Volatility Index became more and more brief, this issue became central.

The Zhitong Finance App notes that last week, the VIX index rose more than 2.3 points twice intraday due to heightened concerns about the escalating conflict between Russia and Ukraine. The VIX Index was up less than 1 point by the close.

More dramatically, during the August 5 volatility shock, stock market volatility indicators were expected to hit record highs, but almost all gains were spilled back in a week. Futures rose far less than expected in recent months on that day.

As the market increasingly sees bad news as an abnormal tail risk, investors are beginning to doubt the real effect of volatility hedging — or their actual value, because monetizing any volatility today requires a very quick return on profits. So-called volatility is usually very high under market pressure, which means that a spike in volatility could quickly turn into a crash — and recently proved difficult to profit from.

Jeremy Wien, managing partner of the stock index volatility fund at Moo Point Capital Management, said: “It is extremely difficult to monetize VIX call options. That being said, VIX's gains are likely to be faster and more drastic than the stock market's decline, so in some cases, VIX call options can be a very useful hedging tool.”

Wien added that VIX call options may be better suited to guard against geopolitical events, while S&P 500 put options may be better suited to hedge against weak economic data, disappointing earnings, or falling stocks linked to artificial intelligence.

In a recent research report, Bank of America strategists, including Matthew Welty, said hedgers who want to choose VIX call options or S&P 500 put options need to consider how responsive the volatility index is, because a sharp fall in the stock market does not necessarily cause a surge in volatility. Bank of America pointed out that the VIX options market has accumulated significant imbalances in 2023 and 2024. This imbalance may not have been completely eliminated, and it may be difficult for traders to hedge during market pressure events, leading to a rise in VIX futures.

On August 5, given the speed of the market crash and the subsequent volatile sell-off, VIX call option holders may have trouble hedging out. A report published by the Bank for International Settlements soon emphasized that before the normal trading session, the spread of S&P 500 put options widened dramatically, leading to an increase in VIX spot prices. Since the VIX spot price is calculated based on the midpoint of the bid price, this price level is likely to rise even without S&P 500 options trading.

Anne Van Kuijk, head of Optiver's Amsterdam S&P 500 Index and VIX Options department, pointed out that in a state of panic, VIX's bullish options were much more convex than S&P 500 put options. Meanwhile, capital inflows into leveraged shorting VIX exchange-traded funds reduced the cost of VIX call options.

Jitesh Kumar, derivatives strategist at Société Générale, said that VIX and S&P 500 products have different uses. When investors buy S&P 500 put options, they buy options that bet on the index level, and when they buy VIX call options, they can remain sensitive regardless of the index level — as long as the volatility doesn't decrease. He added that many market participants also hold VIX tail risk hedging products for regulatory purposes, which is “very beneficial” to them.

Kumar concluded, “Investors need to choose hedging based on a spot/volatility perspective.”