Tuesday, June 27, 2017

One Reason Why VIX Matters

      Like many investors, the nine year bull market has left my fund with a large amount of unrealized capital gains.  With prices now very rich, at least in my view, I feel the risk/return trade-off is much less favorable then when those investment were made.  I fear there is a reasonable probability of a large downside move, whereas further increases on upside are likely to be limited.  One reaction to this view is liquidate those positions.  But that means paying a large capital gains tax.  The tax is particularly onerous for California residents like me because California has a 13% marginal tax rate and NO allowance for capital gains.

       One strategy that appeals to me is writing call options against the positions with large unrealized gains.  That provides some added return in the form of the option premium and, thereby, some downside protection.  Furthermore, if future price appreciation is likely to be small, as I believe, the cost in terms of foregone appreciation is limited.  The downside is that option prices are very low because the expected volatility is a record low levels.  The risks that I see are not reflected in the VIX or in the expected volatilities of many individual stock options.  That makes the option writing strategy much less attractive.  That is a reason the VIX matters.


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