With the markets at all time highs and making new all time highs almost every day now, many are starting to consider the idea of a volatility hedge in the event the uptrend party comes to an end. This one is kind of a controversial topic with traders but today we'll take a closer look at the possibilities of adding a volatility hedge to your portfolio.
Now the question here isn't really how you go about adding the hedge. Now a days you can use any number of great ETF's such as the (NYSE: VXX), there are futures based volatility products, as well as options on all underlying related to volatility. The question today is should you even consider adding this in the first place.
One of the things we want to look at is your time horizon. If you are the type of person who looks to the long term on all your investments and drools at the possibility of them becoming more "discounted" then hedging with volatility will only cost you money in the long run. These types of investors know there are holding through thick and thin and would love for pullbacks to add more to their investments.
If you are a shorter term trader then this is who could really benefit from a volatility hedge. If you are the type that likes to ride a short term trend but worry about company specific news events or even sector related news events then yes I would consider a volatility hedge.
See a volatility hedge will really help you if there is a sudden move in prices. If the markets (or the positions you hold) only decline slowly over time then a volatility hedge will not help you ate all. With a volatility hedge you are protecting against those quick, sharp moves lower that seem to come out of nowhere. These types of moves can wipe out a short term trader, and thus the volatility hedge may be used.