Initiatd on the 4th of April 2025, this position was closed on the 8th of April 2025, from a sense that the market had baked in the likelihood of China’s non-compliance with President Donald Trump’s ultimatum to lift sanctions. The position closed with a return of 34.11%.
Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
William Butler Yeats
One of the great puzzles of the economics of risk is the insurance paradox: assuming a world of expected value maximisation, why does a market for insurance exist if the price at which insurers are willing to provide it is higher than the price at which consumers are willing to pay for it? A solution suggested as early as the eighteenth century by Daniel Bernoulli in my favourite mathematics/finance paper of all, “Exposition of a New Theory on the Measurement of Risk”, gives a powerful answer: in a world where , in the long run, catastrophe is certain, one needs insurance to emerge from catastrophe wealthier than one would without it. Insurance makes the insurer and the insured wealthier.
This is not a long-term thesis, but a short-term, tactical thesis to help navigate the risks of the coming days, and weeks. One of the great realisations I had when I wrote my as yet unpublished Masters’ thesis, “The Nature of Risk”, is that losses have a greater impact on portfolios than gains. In a sketch of an idea, named after my masters thesis, I explained that,
Losses impact portfolios more profoundly than corresponding gains. In truth, although perhaps controversial, this can be shown with very elementary arithmetic: a decay in wealth of 10% requires an 11.11% gain just for an investor to break even, while a 20% decline requires a 25% gain, a 50% decline demands a 100% gain, and a 99% decline requires a miracle. As losses mount, the gains needed just to break even escalate asymmetrically. Whether these losses come in one fell swoop, or in dribs and drabs over time, the demands on a portfolio to earn asymmetrically greater returns soar. Managers and investors are rationally obliged to avoid risk, investing only when they have an edge, and, when doing so, investing in concentrated portfolios, while diversifying across time.
For many investors, this will be a period of escalating losses requiring asymmetrically greater gains just to break even. I see this period as, at a minimum, analogous to the COVID-19 crash, as a period of systemic downturns, an idea that informed my thesis on gold and gold miners. Here, I argue for a tactical, short-term deployment of the ProShares Ultra VIX Short-Term Futures ETF (UVXY) over a holding period of one week to one month. The aim is to not only capture upside potential in hedging volatility but also to protect a concentrated 10-stock portfolio, where 30 to 40% of the value is exposed to steep downturns -such as my position on Meta Platforms-, against tail risk. I suspect I will start off at a loss, and this will carry on till Monday, but as the trade war intensifies and apocalyptic nightmares stalk investors, the UVXY will storm forward.
Downside Volatility Will Be Sustained
At one point, the Wall Street Journal reported that April 3 experienced the second biggest daily loss in U.S. stock market value, with an estimated $3.1 trillion dollars wiped off the market. The WSJ quoted Rob Citrone, a tariff-skeptical hedge fund manager who had bet that the early rally was “crazy”, as saying, “I should have sold more”. I think that that feeling is widespread. When the debris has cleared, there will be a lot of value to be had. I suspect I acted too early with Meta Platforms: the thesis was sound, the timing was terrible. Some investors, citing Warren Buffett’s famous axiom, “Be fearful when others are greedy and greedy when others are fearful”, may swoop in, but that only works if the losses incurred are not so great that one needs a miraculous Covid-sized bounce. Some stocks may not recover for years. The Financial Times later reported that the final losses were $2.1 trillion. My arguments from my gold and gold miners piece remain: we have entered a period of such uncertainty wherein selling will beget more selling, as market participant’s rational fears and their deleveraging and de-risking act to make the market more risky for holders of stocks, a moment of negative momentum, and capital outflows from stocks into gold and other perceived safe haven assets. Furthermore, we await the counter moves of the U.S.’ major trade partners, all of whom have promised strong, carefully considered reactions. This season of mutual blood-letting will send markets into a death spiral until the trade war is called off, or, until there is a sense that a grand bargain can be achieved.
Although value will likely outperform growth, the typical value investor will still return very low returns because of the gravitational pull of this market mayhem. Moreover, because, at 52%, U.S. portfolios were allocated to equities at their highest levels since the Federal Reserve started collecting data in Q1 1951, there were already rational reasons for the aggregate portfolio to exit stocks. This is an era of rational panic. That means, for the next few days to a month, downside volatility will define the market.
The UVXY inversely correlates with the S&P 500 so that during periods of systemic distress, it benefits from these cycles. As the fund sheet explains,
ProShares Ultra VIX Short-Term Futures ETF seeks daily investment results, before fees and expenses, that correspond to one and one-half times (1.5x) the performance of the S&P 500® VIX®Short-Term Futures Index.
However, the dear reader should note that trading such instruments incurs significant transaction costs, with the UVXY having a gross expense ratio of 0.95% compared to 0.0945 for the SPDR S&P 500 ETF Trust. Insurance is expensive. One has to believe that downside volatility will be deep and sustained enough for this to make sense. One must balance the expected gains from hedging with these costs, especially over short holding periods.
Past Analogies
While I suspect that this crash will end up greater than the Covid-19 crash, one can use it as a way of benchmarking expectations. Between March 1 and April 1 2020, the S&P 500 slumped some 16.4%, compared to a rise of 187.7% for the UVXY.
When the UVXY first entered the market October 31 2011, in the wake of the August 2011 stock markets fall, the S&P 500 fell 4.64%, while it gained 21.75%, between October 31 and November 29.
The final analogy is indirect: during the 2008 financial crisis, specifically between 1 August 2008 and 30 July 2009, the CBOE Volatility Index (^VIX) gained 27.6%, while the S&P 500 declined 28.3%.
These are the results of a simple buy-and-hold strategy of an instrument that is typically deployed for very short periods. The results are even greater when the VIX is deployed for shorter periods, before decay sets in as the market recovers. At a base value, I expect to gain 20% over the next month from the UVXY, and higher than that in short bursts.
Execution and its Risks
The reader will have to work out the appropriate position sizing and risk management tactics based to offset potential losses. My guess is that losses could be as large as 30% for the year for this period and by extension, for my risk-exposed positions. To sketch out how to think about it, let V denote the portfolio value and H the hedge allocation. My goal is to choose H such that:
H = (L⋅V)/ΔPETF
where:
- L is the maximum acceptable loss (targeting a reduction in risk exposure by at least 30%),
- ΔPETF is the expected percentage move in the ETF during a crash event.
That allocation can be dynamically adjusted using Bayesian posterior estimates.
The instrument is itself volatile, so a stop-loss order is crucial to preventing a market rally adverse events from exacerbating losses. I recommend setting a stop-loss at a level where losses exceed a predetermined fraction of the hedge position (typically 20 to 30% of H). The UVXY is designed such that it suffers a decay due to futures roll costs, especially in a contango environment. This can erode returns if the market remains volatile without a sustained crash. There is also the issue of timing uncertainty. Miss-estimations are the norm, and can lead to over-or-under-hedging. I could go on. Simply: this is not a guarantee of a gain, either because a sustained crash does not happen, and the fees incurred leave the investor at a net loss, or because the UVXY may not hedge against such a sustained crash in the expected fashion.
Conclusion
Nevertheless, with the commencement of a global trade war, the prospect of stagflation, geopolitical uncertainties fast-emerging, and the possibility of tighter monetary policy, the probability of a sustained market downturn has increased. What is proposed is a tactical, short-term position in the UVXY as a hedge against systemic market crashes. By combining Bayesian probability with quantitative models for position sizing and risk management, and by accounting for transaction costs and market microstructure, the proposed strategy offers a robust framework for preserving portfolio value in these turbulent times. Nevertheless, there are inherent weaknesses, such as the leveraged decay, liquidity risk, and model uncertainty, and these must be closely monitored.