As illustrated in the below image, our sample portfolio contains both stock and volatility instruments. The latter are grouped under "SPX" in the examples, since their value is ultimately derived from SPX volatility.
Risk Navigator supports scenarios with coordinated volatility, and also with no volatility change. The results can be quite different:
Since the price-based part of the portfolio is a short covered call and an outright long position, it loses value as market prices drop. This is reflected in the "What-if" line on the graph, which shows the price-based instruments losing value and the vol-based instruments unchanged.
The vol-based part of the portfolio contains long positions in VXX stock, a VXX call, and a VIX future, all of which will profit from a volatility increase. If a market price drop is accompanied by a volatility increase, then the vol-based instruments will gain value in these market-down scenarios. The "Vol.Coord." line on the graph shows a smaller P&L change, due to this offsetting effect.
It is important to note that such simple scenarios cannot be expected to quantitatively predict the details of a large market move. Both curves are computed from vastly simplified toy models of what might happen in a severe market downturn. Their only goal is to compactly summarize one aspect of a portfolio's potential behavior.
The graph on the Volatility Products tab shows the results of the same volatility-coordinated scenario analysis as that used on the Equity tab.
However, the graph's x-axis is now the volatility change rather than the corresponding price change. Because the volatility-coordinated scenarios associate increasing price and decreasing volatility, the direction of P&L change appears to have reversed. And because the relationship between market price change and volatility change is non-linear, the graph's shape appears to have changed.
The values in the two graphs nonetheless correspond precisely. For instance, a single scenario in which prices increase 10% and nominal volatilities decrease 10% contributes one point on each graph:
Another scenario, in which prices decrease 20% and nominal volatilities increase 200%, contributes a different point:
In scenarios like the latter, the volatility products will experience a positive P&L; but because the volatility increase is assumed to be accompanied by a decline in market prices, the price-based products will experience a negative P&L in the same scenario. The graph shows the sum of these two effects.