Tryon is long several equity positions based on event-driven ideas that, over the next few quarters, are expected to have double-digit returns. He is concerned, however, that the equity market may decline as a result of lower corporate earnings. He believes investors are complacent as reflected in the historically low level of the volatility index (VIX). He wants to establish volatility exposure as a tail hedge for his holdings and notices the VIX futures curve is in contango. Tryon evaluates three potential trades to establish his hedge:
- Trade 1: Go long back-end month futures contracts on the VIX Index, with a gross notional equal to the portfolio market value.
- Trade 2: Sell a rolling series of out-of-the-money put options on VIX futures.
- Trade 3: Go long a variance swap, with vega notional equal to the potential equity portfolio loss.
Doubt - I understand why the answer is 3 but don’t understand the nature of VIX Puts. Tyron knows that equity will decline because of decline in corporate earnings. Since VIX is inverse to equity, the VIX would rise. This goes against puts as in puts you expect vol to fall, so selling them would be opposite of buying then why is B wrong. I understand my logic is wrong but where am i going wrong?