JP Morgan Volatility Trade

Back in 2010, a time when the extreme gyrations of the previous two years were fresh in investors’ minds, JP Morgan created a special equity volatility index. It could be used as a hedge against crises— it rakes in money when volatility jumps.

But the index can also go short on volatility, depending on the direction of the VIX benchmark on S&P 500 fluctuations. Some hedge funds find it of interest.

The JP Morgan index is synthetic in the sense that it does not trade the S&P 500. Both long and short positions are achieved by buying and selling VIX futures.

Had the index been in operation during the crisis in the American financial system, it would have returned 95% in 2008 and 62% in 2009—net of a 0.75 index fee. But those are hypothetical numbers obtained by applying the model retroactively. Last year it made a real 8%.

The only yearly loss so far, again hypothetical, was a 2.3% downer in 2007. But the index has had 10%-11% monthly losses, as well as outsized monthly gains. Its synthetic character adds risk.

This is not related to the recent whale trades that lost $6-billion-plus, despite the common element of using a synthetic instrument. Those involved credit derivatives with ambiguous valuations, whereas the volatility index relies on futures contracts with clear exchange prices. JP Morgan Securities runs the index operation, not the investment office where the whale loss happened.

Nevertheless, if you have read the massive report that came out from the US Senate Subcommittee on Investigations last month, you can’t but help wonder. According to that report: “In contrast to JP Morgan Chase’s reputation for best-in-class risk management, the whale trades exposed a bank culture in which risk limit breaches were routinely disregarded, risk metrics were frequently criticized or downplayed …”

Those looking to buy notes linked to the JP Morgan Volatility Index can derive comfort from the model’s risk metrics, but there is the question of whether these could be ignored.

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One Response to “JP Morgan Volatility Trade”

  1. The Joy of Randomness | HedgeFundSmarts Says:

    […] Top News and Analysis about Non-Traditional Investing « JP Morgan Volatility Trade […]

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