The View from the Hill - Perspectives on Markets and Strategies

The Risk Shift: Higher for Longer
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As we look ahead to the remainder of 2020, it is apparent that our professional and personal lives have been altered in dramatic ways that few of us could have foreseen. We now have the hard work of adapting to this “containment” period between the peak of the virus spread and the administration of a tested and effective vaccine. This means changing the way we work, connect with families and friends, and enjoy our leisure time. It is only logical that it may call for changes in the way we approach our investment holdings as well.

The worst of the market turbulence may be behind us now that central banks have taken steps and fiscal measures have been put in place to ease the impact. Equities posted a major rebound as evidenced by the S&P 500 Index moving back above 3,000. But how should we be thinking about the long-term risk picture as we develop strategies and targets for return for the remainder of 2020? This question is complicated by the fact that this is a presidential election year, with the possibility of a change in party leadership in November that has important policy implications.

Certainly, there are many shifts occurring under the surface of the broad equity market as whole industries are almost fully shut down and will reemerge in quite transformed ways. But a simple look at the Cboe Volatility Index (VIX) and expectations for the VIX for the rest of the year provides some interesting insights into the long-term risk picture. The VIX looks at expected volatility of the S&P 500 for the next 30 days as reflected in S&P 500 option prices. VIX futures trade for each month, showing the market’s expectation for the VIX as of expiration on the third Wednesday of each month out through the rest of the year. Therefore, the VIX futures curve can reveal what market participants are expecting for equity risk over the remainder of 2020.

The first point to note is the significant upward shift of the VIX. As shown in the table and chart below, the VIX at 26% as of June 8 is still significantly higher than the 15% level on February 20, before the COVID-19 news impacted markets. Now that the S&P 500 has rebounded well above the 3,000 level.  The VIX is also close to the levels on February 24 when the news of pandemic was just beginning to be priced into equities and the S&P 500 index was at similar levels. 

VIX & VIX Futures Prices*

    6/8/20 2/24/20 2/20/20
VIX Spot
VIX Futures Expiration Month
S&P 500

*June/July/August VIX Futures pricing shown for June 8, 2020 / March/April/May VIX Futures pricing shown for February 20 and 24, 2020.
Source: Bloomberg and Cboe.

VIX & VIX Futures Prices*

February vs. June 2020

Source: Bloomberg and Cboe.

But what is different now is that expectations for the VIX over the remainder of the year as implied by the prices of VIX futures have changed dramatically. The table and chart show VIX futures prices for different expirations through 2020 in February and in early June.  Recently, the VIX futures curve shows pricing well above the current VIX level (technically called “contango”) through the November expiration date, which reflects VIX expectation through mid-December.  Note also that the October VIX future that shows VIX expectations from mid-October through mid-November has a slight premium to reflect higher expected volatility over the Presidential Election period.  To put this expected VIX level into context, keep in mind that the average between 1990 and April 2020 was 19.3% (median 17.3%). This means VIX futures are implying that we are likely to see volatility stay about 50% above normal through year-end.

What are the implications for investment strategies? At these elevated risk levels for holding U.S. equities, investors need to think carefully about their overall equity exposure and whether their return expectations for equities are commensurate with this higher expected risk. If the answer is yes, few changes are required in the overall equity allocation. For investors whose return expectations are more measured or who have lower risk tolerance, a shift down in equity risk exposure overall for their portfolios may be warranted until volatility conditions fall closer to normal levels. This can be handled in the conventional way by adding fixed income investments with short-term maturities and low levels of credit risk, or by utilizing smart beta or active equity strategies that have lower equity risk. For investors comfortable with strategies that incorporate options, equity hedging strategies such as buffer mutual or exchange-traded funds (ETFs), can be effective at reducing downside risk for a range of index levels at the expense of forgoing some upside returns. Another alternative is to utilize covered call selling positioned around return targets, to take advantage of the higher expected volatility incorporated into equity index and stock options. 

Regardless of the approach, it is prudent to be aware of the continued high expected risk levels for holding equities and to factor higher volatility expectations into investment strategies for the coming months. Even though equity markets rebounded sharply from their March lows, there remains a great deal of uncertainty ahead. Corporate leaders are working hard to adapt their business strategies to a world dominated by contagion risk and an uncertain time frame for a vaccine. Just as these corporate leaders are making critical changes to how their companies operate, investors should be aware of how their investment approaches can be altered for the potentially volatile remainder of 2020.


The views, opinions, and content presented are for informational purposes only. They are not intended to reflect a current or past recommendation; investment, legal, tax, or accounting advice of any kind; or a solicitation of an offer to buy or sell any securities or investment services. Nothing presented should be considered to be an offer to provide any Cboe Vest product or service in any jurisdiction that would be unlawful under the securities laws of that jurisdiction. The charts and/or graphs contained herein are for educational purposes only and should not be used to predict security prices or market levels. Cboe Vest has made every attempt to ensure the accuracy and reliability of the information provided, but it cannot be guaranteed. Past performance is no guarantee of future results.