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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