VIX Futures and options: A Case Study of Portfolio Diversification During the 2008 Financial Crisis

Abstract

In 2008, the S&P 500 experienced a drawdown of about 50% from peak to trough. Many assets which are typically considered effective equity diversifiers also faced precipitous losses. Most hedge fund strategies and commodity indices were not immune from declining. For example, the HFRX Global Hedge Fund Index had a maximum drawdown of approximately 25% of its value in 2008, with some of its sub-indexes dropping almost 60%. The drop in commodities was even more significant. The S&P GSCI commodity index experienced a maximum drawdown of about 2/3 of its value in 2008. In stark contrast, volatility levels as measured by VIX experienced significant increases and in 2008 repeatedly set new highs not seen since the crash of 1987. This study assesses the impact of a long VIX investment as a diversifier for a typical institutional investment portfolio during the 2008 credit crisis.