When will VIX be a Perfect Hedge?

Many investors has heard about "Fear Index", which was corresponding to $S&P 500(.SPX)$ index, the $Cboe Volatility Index(VIX)$. It shows the trend of the market volatility, so it is widely used by investors as a hedging tool.

Can VIX perfectly hedge market downturn?

No.

First, we must understand that what is a Volatility index.

What is volatility?

Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security. Volatility is often measured from either the standard deviation or variance between returns from that same security or market index

VIX is created and managed by $CBOE Holdings Inc(CBOE)$, It is an important index in the world of trading and investment because it provides a quantifiable measure of market risk and investors’ sentiments. It isInverse derivation from the price of SPX index options with recent maturity (Option pricing methods, such as Black-Scholes model), So it generates a 30-day forward-looking forecast of volatility.

Volatility or the speed of price change is usually regarded as a way to measure market sentiment, especially the degree of fearness of market participants, so it is called "fear index".

When will there be VIX and SPX move on the same side?

We need to understand how VIX is calculated.

VIX values are calculated using the Cboe-traded standard SPX options, which expire on the third Friday of each month, and the weekly SPX options, which expire on all other Fridays. Only SPX options are considered whose expiry period lies within more than 23 days and less than 37 days

In most cases, the S&P 500 index and VIX move in opposite directions.

However, when the plunge continues for more than a month, unless the volatility of each next day is greater than that of 30 days ago, the VIX will maintain a steady high level or drop impressively. For example, at the end of March 2020, because of the sharp drop for one month, it appearedThe S&P 500 Index and Fear Index were in "double kill".

Following the popularity of the VIX, the Cboe now offers several other variants for measuring broad market volatility. Examples include the Cboe Short-Term Volatility Index (VIX9D), which reflects the nine-day expected volatility of the S&P 500 Index; the Cboe S&P 500 3-Month Volatility Index (VIX3M); and the Cboe S&P 500 6-Month Volatility Index (VIX6M). Products based on other market indexes include the Nasdaq-100 Volatility Index (VXN); the Cboe DJIA Volatility Index (VXD); and the Cboe Russell 2000 Volatility Index (RVX).

What are the characteristics of volatility-related products?

VIX is only a measurement index, not a trading underlying, its derivatives are tradable, like futures, options, ETN, ETF and other products.

For example, $Barclays iPath Series B S&P 500 VIX Short-Term Futures(VXX)$,$ProShares VIX Short-Term Futures ETF(VIXY)$, and some legerage products, $VelocityShares Daily 2x VIX Short-Term ETN(TVIX)$$VIX Short-Term Futures 1.5X ETF(UVXY)$.

The factors that determine these financial products are not just VIX index.

UVXY, for example, has a backup of VIX futures contracts for the current month, VIX futures contracts for the next month, and a small amount of short-term government bonds.

VIXY similar

Futures have contago and backwardation, T-Bonds are sensitive to interest rate level, not to mention that a leveraged ETF . Therefore, the financial products related to VIX have considerable tracking errors.

If you only want to hedge downturn risks in the short term, choosing ETF, ETN is favorable, because it is more convenient. However, if you want to "trade volatility", you need to choose futures, options and other products.

You can refer to this post:"A sharp weapon used by hedge funds-volatility targeting"