Since the Great Recession, the stock market has enjoyed an extended period of low volatility as one of the longest bull runs in history, fueled by quantitative easing programs and corporate buybacks, pushed stock prices substantially higher.
This prolonged period of low volatility ended abruptly in the first quarter of 2018 as investors began to fret over higher interest rates after a particularly upbeat January jobs report. On Feb. 5, 2018, The S&P 500 Index plummeted over 4%, which sent the Chicago Board Options Exchange's (CBOE) Volatility Index (VIX) soaring above 50 for a daily gain of 115%. (See also: February Stock Market Volatility Didn't Hurt ETFs.)
Other catalysts for increased volatility in the second half of 2018 include elections in leading emerging markets such as Turkey, Mexico and Brazil as well as midterm elections in the United States. Additionally, looming trade wars between the United States and several of its closest allies have the potential to further unnerve investors. (For more, see: 6 Stocks at High Risk in a Trade War.)
Volatility may also rear its head over the July and October earning seasons during the corporate buyback blackout period – a time when companies are prohibited from repurchasing their shares in the lead up to releasing quarterly results. This effectively reduces a significant source of liquidity from the market that can make stock prices erratic.
Investors who wish to protect their portfolio against volatility or take a short-term trade to exploit a sudden spike in volatility should consider purchasing one of these four exchange-traded products (ETPs).
iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX)
Barclays PLC (NYSE: BCS) launched the iPath S&P 500 VIX Short-Term Futures exchange-traded note (ETN) in 2009. The ETN seeks to provide investors with exposure to the S&P 500 VIX Short-Term Futures Index. This index comprises a daily rolling long position in first- and second-month VIX futures contracts to reflect the implied volatility of the S&P 500 index. VXX has an average daily volume of $1.16 billion, which provides ample liquidity for traders who wish to use this instrument to hedge their equity positions. Barclay's credit backs the ETN.
The iPath S&P 500 VIX Short-Term Futures ETN is one of the largest volatility ETNs, with assets under management (AUM) of $821.43 million. It has an expense ratio of 0.89%, which compares with the category average of 1.34%. Year to date (YTD), VXX has returned 14.94% as of June 2018. (See also: VXX: An ETN Performance Case Study.)
Formed in 2011, the ProShares Ultra VIX Short-Term Futures exchange-traded fund (ETF) attempts to match one and a half times (1.5x) the daily performance of the S&P 500 VIX Short-Term Futures Index. Like VXX, this ETF is a pure play volatility ETF that provides exposure to first- and second-month VIX futures contracts; it differs by delivering leveraged returns.
The ProShares Ultra VIX Short-Term Futures ETF has $471.36 million in net assets. Its high expense ratio of 1.65% makes it more suited to short-term traders who anticipate a sudden spike in volatility. As of June 2018, UVXY is trading at $10.05 and has a 52-week trading range between $9.98 and $47.16. (For more, see: Top 4 Inverse Volatility ETFs.)
Created in 2017, the Nationwide Risk-Based U.S. Equity ETF aims to offer similar returns to the R Risk-Based U.S. Equity Index. The benchmark index is an equal-risk weighted index that provides exposure to large-capitalization companies with lower volatility and reduced maximum drawdowns. It attempts to increase risk-adjusted returns compared with traditional market cap-weighted approaches. Top holdings in the ETF's portfolio, which consists of 249 stocks, include Dr Pepper Snapple Inc. (NYSE: DPS), NXP Semiconductors NV (NASDAQ: NXPI) and utilities company The Southern Company (NYSE: SO).
The Nationwide Risk-Based U.S. Equity ETF has $118.56 million in net assets and charges investors an annual fee of 0.3%. As of June 2018, RBUS has a YTD return of 0.15%, but it has returned 2.42% over the past month.
Formed in 2012, the Invesco S&P 500 Downside Hedged ETF attempts to provide investors with positive returns in both rising and falling markets. It tries to achieve this by investing its $25.72 million asset base in stocks that are constitutes of the S&P 500 Index and by purchasing VIX index futures contracts to hedge the portfolio. The top 10 stocks in the ETF's portfolio have a cumulative weighting of 23.68% and include names such as Apple Inc. (NASDAQ: AAPL), Microsoft Corporation (NASDAQ: MSFT) and energy bellwether Exxon Mobil Corporation (NYSE: XOM).
The Invesco S&P 500 Downside Hedged ETF has an expense ratio of 0.39%, which is very reasonable given its hedged construction. It also pays a 1.98% dividend yield. The fund has returned 3.62% over the past five years and 4.34% over the previous three years. It has returned 5.05% YTD as of June 2018. (For additional reading, check out: Hedging with ETFs: A Cost-Effective Alternative.)