American Consequences - October 2019

CBOE Volatility Index ($VIX) Spikes During Bear Markets

50%

Bear markets in gray

40%

30%

CBOE Volatility Index

20%

10%

3.0% 6.0% 9.0%

When folks are fearful and want put-option protection, the cost of protection increases dramatically...

0.0% -3.0% -6.0% -9.0% -12.0%

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The VIX is calculated by looking at how much people are paying for S&P 500 options expiring in the next two months. It gives us a sense of how wild investors expect the market swings to be over the next month or so. When folks are fearful and want put-option protection, the cost of protection increases dramatically... You can also see how a surge in volatility pushes up put premiums from the table below. The price of a put option on the S&P 500 can jump around 400% when volatility spikes. But buying puts costs you money if the bear market doesn’t come. That’s why you need to keep any hedges very small. The thought here isn’t to get rich off a bear market collapse... You just want a little bit (1% or 2%) to smooth out your returns.

PREPARE FOR THE NEXT BEAR With all this information about bear markets, what do we do? The prescription for survival is rather simple... Take a long-term view: If you have the luxury of investing for five or 10 years into the future, the next bear market will come and go before you need any cash. Make sure your mindset matches your time horizon, and don’t worry about what doesn’t matter. Diversify with bonds: You need some ballast to keep your portfolio steady in tough times. Bonds give you the opportunity to earn returns and have capital ready to deploy. All you need is a high-quality mutual fund or exchange-traded fund like iShares iBoxx Investment Grade Corporate Bond Fund (LQD) or something that may be available in your retirement account like the Vanguard Total Bond Market Index Fund (BND) or the

American Consequences

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