Volatility Multi-Asset Chart

Downside Protection—at What Cost?

31 January 2018

1 min read

Today’s Environment Doesn’t Support Buying Volatility

Historical Returns for Long-Option Strategy Based on Key Drivers

As of December 31, 2017
Past performance is not necessarily indicative of future results. There is no guarantee that any estimates or forecasts will be realized.
Historical returns measure the carrying costs of optionality, using delta hedging, for various option-market drivers by quintile from January 1, 1983, through December 31, 2017. Volatility slope is the difference between three-month and one-month options for the S&P 500 Index. Volatility risk premium is implied volatility minus realized volatility.
Source: MSCI, S&P and AllianceBernstein (AB)

Investors worried about an equity correction might see low volatility as a sign that buying options is a cheap way to protect a multi-asset portfolio. But the cost today is higher than it seems.

Implied volatility is indeed very low, with the VIX ranging from 10 to 12 lately. But there’s more to determining how cost-effective it is to “buy volatility” as downside protection. We look at three key components to make the determination.

First, realized volatility—the actual day-to-day variation in asset prices—is itself very low. This suggests that there’s less need to find protection against an increase in volatility. Second, longer-term options are more costly than normal versus shorter-term options, adding to the cost of carry for a long-option position. Third, the difference between implied and realized volatility—the volatility risk premium—is close to average, indicating a roughly neutral signal for the attractiveness of long-option positions.

When we take these three considerations together, a long-option strategy seems expensive today. We think it makes sense to consider other ways to protect against drawdowns and volatility. At the core are keeping your allocation flexible and using a broad array of signals to determine adjustments.

But other measures can help to keep balance in portfolio risk. These include overweighting currencies (like the US dollar and the yen) that tend to outperform when volatility rises and not abandoning duration.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

This information is for exclusive use of the wholesale person to whom it is provided and is not to be relied upon by any other person. It is not intended for retail or public use and may not be further distributed without prior written consent of ABAL.
This webpage has been prepared by AllianceBernstein Australia Limited (“ABAL”)—ABN 53 095 022 718, AFSL 230 698. Information in this webpage is only intended for persons that qualify as “wholesale clients,” as defined by the Financial Markets Conduct Act 2013’, and is not to be construed as advice. This webpage is provided solely for informational purposes and is not an offer to buy or sell securities. The information, forecasts and opinions set forth in this webpage have not been prepared for any recipient’s specific investment objectives, financial situation or particular needs. Neither this webpage nor the information contained in it are intended to take the place of professional advice.
You should not take action on specific issues based on the information contained in this webpage without first obtaining professional advice. Past performance does not guarantee future results. Projections, although based on current information, may not be realized. Information, forecasts and opinions can change without notice and ABAL does not guarantee the accuracy of the information at any particular time. Although care has been exercised in compiling the information contained in this webpage, ABAL does not warrant that this webpage is free from errors, inaccuracies or omissions. ABAL disclaims any liability for damage or loss arising from reliance upon any matter contained in this webpage except for statutory liability which cannot be excluded.
No reproduction of the materials on this webpage may be made without the express written permission of ABAL. This information is provided for persons in Australia only and is not being provided for the use of any person who is in any other country.

Downside Protection—at What Cost?

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