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Bet on Tech, Hedge the Volatility

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Since the dot-com bubble at the turn of the century – or perhaps, despite it – American Tech has become increasingly dominant in the U.S. market. As manufacturing shifted away from American shores in droves, tech remained the dominant means of catalysing consumption and the American edge over the world. With 7-10 major components of any broad U.S. index being tech companies, it could be argued that no bet on the American economy via a broad index is incomplete without the consideration of tech companies.

However, this overwhelming dominance of tech brings with it substantial risks. With conviction increasingly centred on tech comes volatility due to inevitable overvaluation. Thus, while the likes of the tech-heavy Nasdaq-100 becomes an important consideration for asset managers – in the form of the Invesco QQQ Trust (QQQ) – the prospect of a cool-off in tech convictions dragging down this key index’s performance is ever-present. A strategy to hedge against this is very much in order.

One means of pursuing this would be via the iPath S&P 500 VIX Short-Term Futures ETN (VXX). This ETN (or “Exchange-Traded Note”) is linked to the daily price changes in Cboe Volatility Index, which is often referred to as the “market’s fear gauge” as it tends to rise during periods of market uncertainty and spike in times of panic. A real-time index that indicates the expected level of price fluctuation in the S&P 500 Index options over the next 12 months, the VIX encapsulates expectations of future volatility (or “implied volatility”). In general, uncertainty tends to spikes the prices of the S&P 500 Index option while the lack of uncertainty cools them.

VXX tracks the S&P 500 VIX Short-Term Futures Total Return Index, which offers exposure to long positions in Cboe Volatility Index futures contracts. Therefore, the VXX essentially becomes a bundle of futures contract on market volatility. Now, longer-dated futures contracts tend to be higher levels than shorter-dated ones, the VXX continually sells the futures contracts closest to expiration to buy the next dated contracts in a “rolling” process.

In essence, the VXX forms an important source of information on the “directionality” of the “broader” market S&P 500. Over the past full 12 calendar months, the overall month-wise trajectory has been oppositional between the two more often than not.

Websim is the retail division of Intermonte, the primary intermediary of the Italian stock exchange for institutional investors. Leverage Shares often features in its speculative analysis based on macros/fundamentals. However, the information is published in Italian. To provide better information for our non-Italian investors, we bring to you a quick translation of the analysis they present to Italian retail investors. To ensure rapid delivery, text in the charts will not be translated. The views expressed here are of Websim. Leverage Shares in no way endorses these views. If you are unsure about the suitability of an investment, please seek financial advice. View the original at

In the event when both VXX and the “broader” market have been synchronized in month-wise fall, the VXX has led the market.

Under the macroeconomic framework broadly understood, it could be reasoned that when the “broader” market rises, the “tech-heavy” market tends to rise a little higher. This tends to hold true in the other direction when the “broader” market falls. In the same period of consideration, all three of these instruments have shown behaviour that largely falls along these expected lines.

Thus, using a short (or “inverse”) exposure VXX as a “hedge” against the QQQ has one of two effects on a QQQ investment in a bullish outlook:

  • When certainty firms up, the VXX falls while the tech-heavy market rises. Thus, the hedge is a boost.

  • When certainty falters, the VXX rises and the hedge pares off some gains made in the tech-heavy market.

On the other hand, when certainty firms up during a bearish environment, the VXX falls while the tech-heavy market falls. In this case, the hedge pares some of the losses in the market.

Of course, it’s possible that there will be high uncertainty and bearish pressure on the tech-heavy market. This would be a two-headed cost to the strategy’s performance.

Hence, it’s not a perfect 1:1 hedge and active management is needed. This is now easily accessible to sophisticated investors by virtue of the recently launched “LS Short Volatility Long Tech ETP” (LSE: SVLT; ISIN: XS2595675641). This ETP (or “Exchange-Traded Product”) pairs QQQ with VXX via a proprietary methodology wherein the portfolio is rebalanced on a quarterly basis such that the short exposure to volatility will generally be in the 15% range relative to a long exposure to QQQ of 100%. The portfolio manager maintains discretionary powers to modify the short exposure in response to changing market outlook.

In the backtested period going back one year relative to the 23rdf of June this year, SVLT has delivered a return of over 46% while the S&P 500 and Nasdaq-100 have been a little over 17% and 12% respectively.

Upon a decline in conviction in the broad market, two effects can be assumed will take place:

  1. There will be a “crowding” effect into tech stocks since they’re being deemed more survivable than most of the other “non-tech” companies. This will likely push up tech valuations while market volatility continues to plummet. This will not be a sustained movement; eventually tech stocks will have to follow the rest of the market.

  2. There will be an “inflection point” when the drop in stock valuation will no longer be countered by the rise in the hedged position in volatility. Volatility will have plateaued at this point. At this moment, holding the ETP would have a best-case scenario of being equivalent to holding the tech-heavy ETF itself. After this is the “grey zone”: market movement from this point onwards will determine which is the better choice.

Until then, holding the instrument is likely to have some tangible potential. This type of ETP – unlike “fixed-factor” ETPs – offers sophisticated investors access to a strategy that draws on the portfolio manager’s experience and alacrity at an affordable price point. In this case, it’s a strategy that effectively gives exposure to a tech-heavy market – via the QQQ ETF – while tempering/enhancing performance through a calculated and dynamic “inverse” bet on volatility – made possible via the VXX ETN. Given that these are two different classes of instrument, the ETP thus paves the way towards effectively delivering a strategy in a price-friendly manner. In other words, sophisticated investors are bound to find SVLT to be a very effective yet balanced strategy to gaining exposure to the tech-heavy top of the line in the American equity market.

Investors interested in knowing more can.click here.

Your capital is at risk if you invest. You could lose all your investment. Please see the full risk warning here.

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Market conditions prime SVLT for outperformance against the Nasdaq-100
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