Investing

Avoid Short Volatility Products

Photo Credit: Niccolò Ubalducci || Tornados are similar to financial events where volatility erupts. You can predict them in aggregate, but not in specific

Remember when I wrote Where Money Goes to Die? Well, short volatility products cratered, but cryptocurrencies treaded water, with a lot of volatility.

I am telling you today to avoid short volatility products again. This seems to be a case where people don’t learn. Why? Because there is seemingly free yield from shorting volatility in the bull phase of the equity market. The opposite side of the trade is a disaster as well…. indicating that timing has to be precise if you are trying to earn money off of rising volatility.

Here is an additional reason to avoid short volatility products: the stock market is priced to produce a return of 2.5%/year over the next 10 years. The only time that has been lower than that is during the dot-com bubble.

In this situation, with valuations so high, it would not take much of a scare to make the market drop sharply, which would make volatility jump. Many short volatility products would be wiped out.

So, if you own short volatility products, sell them now. I am not saying “buy long volatility products” because that is a gambler’s game. It is a time to protect principal, not a time to seek speculative gains.

Source: alephblog.com

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