By Wayne Arnold

To hear the financial community tell it, we are all about to die from an incredibly contagious, painful and frightening disease -- you guessed it, volatility.

Volatility has hit global financial markets and you, the investor, should be hiding under your bed, calling your broker and re-allocating your entire portfolio to minimize your exposure to this virulent pathogen.

There is after all, an awful lot to worry about: whether the Germans will maintain a spending sitzkrieg that slowly exsanguinates Europe's economy and hurls it into a new debt crisis; whether the Federal Reserve will raise rates abruptly or, worse, fire up the printing presses again; whether China's economy will slow too fast to keep its credit bubble from bursting; whether ISIS will capture Iraq's oil fields and turn to Saudi Arabia; and, of course, whether Ebola will rage uncontrolled around the world.

Whatever its inspiration, volatility can indeed be bad for investors and economies. Volatility makes it harder for companies to predict costs and plan expansion. That in turn can hurt economic growth by discouraging capital investment. Volatility also raises the cost of hedging, which hurts corporate profits and can sap stock prices.

Worst of all, volatility is infectious. Volatility makes it harder to predict returns for investors who borrow cash to buy securities -- or borrow securities to sell -- and so reduces risk appetite. Volatility can thus punish smaller companies and economies that investors consider more vulnerable to capital flows, such as India, Indonesia and New Zealand.

Yet even though markets have become more volatile in the past month, they're not, relatively speaking, all that volatile. In fact, the most remarkable thing about volatility lately is that it's bouncing back from some pretty breathtaking lows.

Volatility on the S&P500, for example, has soared to its highest since mid-2012, but that's only after it sank in July to its lowest in a decade. On this side of the Pacific, volatility is even less exciting. Volatility on Australian stocks has rocketed to the highest since the middle of last year - after sinking in June to its lowest since 2005. Similarly, Hong Kong's stock market has regained volatility on a par with April, after falling in June to the lowest since 2006.

So why all the hand-wringing over volatility? One explanation is that markets have short memories. Another is that volatility's comeback is a great marketing opportunity. While volatility is perilous for investors and companies, it is essential to traders, brokers and investment advisers, who profit from the higher volumes, greater uncertainty and wider spreads that volatility creates.

Until volatility began climbing in September, in fact, the most common complaint in the financial community was that volatility was too low. Traders were cursing the bull market in global markets created by the Fed's quantitative easing as the most despised rally in memory.

Finally, the flow of scary news stories has hit pay dirt. That's not entirely bad: keeping a higher supply of traders and brokers around increases liquidity and lowers costs for investors.

Investors can make a friend of volatility, too. One of the simplest and most popular ways is to buy securities tied to the Chicago Board Options Exchange Volatility Index, or VIX, which tracks volatility on the S&P500. There's even an ETF, the ProShares VIX Short-Term Futures ETF ( SVXY), that seeks to track VIX. Investors can also buy VIX futures and options.

Rising volatility makes options on other indexes and individual stocks a more enticing option, too? The odds of any option suddenly bouncing into the money rise the higher the market's volatility does. Even if the option doesn't hit its strike price, investors can sell it for a profit long before its expiration.

Indeed, there's even a way to bet prices will bounce around without having to bet which way they'll bounce: buying a so-called straddle. Investors with a high tolerance for potential losses can sell a "strangle" -- a bet that prices will stay range-bound.

There are less exotic ways to profit from rising volatility. One is to buy stocks in the folks that stand to benefit the most -- stockbrokers like Japan's Daiwa Securities ( 8601.JP), Hong Kong Exchanges and Clearing ( 388.HK), or South Korea's Kiwoom Securities (039490.KS).

Then there's the old-fashioned way of taking advantage of volatility: get out from under the bed with cash at the ready to snap up the undervalued stocks created as panicked investors flee.

Comments? E-mail us at wayne.arnold@barrons.com

Comments? E-mail us at asiaeditors@barrons.com

 
 
 

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