VXX and VIX Trading

[PaulCao]

Hi,

 

I was doing some research on VXX and if you pull up any charts for any long-term, it's obvious to casual observers that VXX does not track VIX at all,

 

http://www.seeitmarket.com/exposing-the-vxx-understanding-volatility-contango-and-time-decay/

 

The issue is due to the fact that VXX doesn't track VIX, but rather tracks a 30-day rolling window of a near month VIX future and a back month VIX future,

 

http://www.ipathetn.com/us/product/VXX/#/dollarweights

 

In the case when VIX future's are trading in contango, e.g., the near month VIX future is less than back month VIX future, VXX fund manager everyday is selling his cheaper VIX future in exchange for more expensive VIX future for a loss,

 

Right now VIX April futures is trading at 14.65 while VIX May futures is trading at 15.70, reflecting the market sentiment that VIX will always revert to mean of 15.

 

In this scenario, given that VIX is in contango, VXX should be performing worse than VIX (and vice versa if VIX was trading in backwardation).

 

I plan to make a test trade to trade out this idea: 

I'll sell VXX calls and buy VIX calls; because they are not perfectly-sized; VXX is trading at 20 while VIX is at 12 something. For the remaining unhedged delta on VXX, I'll hedge with VXX underlying,

 

Has anyone done this before; or are knowledgable about VIX, please comment. I'll report back with performance,

 

Best,

PC

[Marco]

if you trade enough contracts that you can trade in a ratio the different price of VIX and VXX is the least of your issues.

 

You are facing the same problem on VIX as with VXX though as you dont buy calls on VIX spot but on the VIX future.

Take today. As I write this the VIX spot is 13.90 and the April future is 14.40, the May future is 15.55 if VIX spot stays unchanged until the April future expires the future will converge (pretty much) to the VIX spot - so 13.90. If you buy a 14 Call with April expiry it is in the money now but it will expire worthless at expiry in above scenario.

So as you trade VIX futures or option on it you face the same issue as if you trade VXX - the futures drift down the curve towards spot (assuming contango and VIX spot pretty unchanged - to see 'the curve' have a look here.)

The difference between VIX and VXX is that VIX has a fixed maturity (if you trade VIX April futures or options the maturity will shorten every day and it will expire/settle on April expiry) whereas VXX keeps rolling from front to back month future to maintain a 30 day maturity. So right after the Mar VIX future expires it will be 100% in April futures (so ~30 days maturity) and with every day passing it will sell some April and buy some May so that the average weight is ~30 days maturity. If you have VXX vs VIX right after the Mar expiry you have the same thing but then every day your VIX position becomes shorter dated while VXX will maintain a 30 day exposure to VIX futures which gives that spread a dynamic which is hard to control in my opinion.

 

You don't make money because VXX will drifts down and VIX doesn't - which seems to be you idea if I understand you right. As explained the futures also drift down. You might make money IF just before your options expire VIX spikes a lot as then you are long an option on a future which also expires in a few days and is therefore more sensitive to a VIX spike and you are short an option on an underlying (VXX) that is essentially a position in mostly back month future which will be less sensitive to a sudden spike in VIX 

 

hope that makes sense.

Marco.

[cwelsh]

I've had a great trade for the last two years now:

 

1.  Buy DITM, far dated, VXX puts. I challenge you to find ANY 180 day period where the value of the VXX did not drop.  (When looking at the chart, don't forget that VXX has gone under several reverse splits and account for those).

 

2.  Hold until you have a 10-15 % return.  Sell, open again 180 days out. 

 

I have yet to lose on this trade.  It requires patience, as sometimes VXX does increase, and you have to watch your portfolio balance get crushed, but it comes back down.

 

Will this always work?  I highly doubt it, either (a) we'll have a prolonged crash as we did in 2008 and I'll get torched, or ( people with bigger wallets who are smarter than me will price me out.  E.g. allocation is key.  I never have more than 3-5% of my portfolio in this trade.

 

I also find it very interesting that Barclays ADMITS they take the opposite side of this trade every month, and make a killing doing it.  In other words, they know this instrument is a POS, that will always lose value, but they market the crap out of it, attract billions of dollars into it, then make money taking the opposite position while at the same time making money on loads, management fees, and commissions.  I'll leave the ethics of that too you, but if the company who designed it, takes very large positions against it regularly, that should tell you all you need to  know.

 

Again though, I can't emphasize enough, understand the risk involved in naked puts. 

[Marco]

Just reading over your post again -  you think VIX (spot) is going back to 15? What I wrote above shows in the price of the 15 Call for April VIX (futures) with spot now at 14.40 and April futures at 14.60 the option costs 1.30 (mid) so you wont make money on that until VIX spot at April expiry is above 16.30 so VIX spot can go up by 13% and you still dont make money on that Call. If you sell VXX slightly OOM calls against that - so maybe April 21 with VXX at 20.41-  you only get 1.48$ for that and if you do that in about 0.70 ratio (14.4/20.41) then you have less (1.48*.70 = 1.04) premium then you pay for the VIX option so even if both end up worthless you lost money ...

[Marco]

I've had a great trade for the last two years now:

 

1.  Buy DITM, far dated, VXX puts. I challenge you to find ANY 180 day period where the value of the VXX did not drop.  (When looking at the chart, don't forget that VXX has gone under several reverse splits and account for those).

 

2.  Hold until you have a 10-15 % return.  Sell, open again 180 days out. 

 

I have yet to lose on this trade.  It requires patience, as sometimes VXX does increase, and you have to watch your portfolio balance get crushed, but it comes back down.

 

Will this always work?  I highly doubt it, either (a) we'll have a prolonged crash as we did in 2008 and I'll get torched, or ( people with bigger wallets who are smarter than me will price me out.  E.g. allocation is key.  I never have more than 3-5% of my portfolio in this trade.

 

I also find it very interesting that Barclays ADMITS they take the opposite side of this trade every month, and make a killing doing it.  In other words, they know this instrument is a POS, that will always lose value, but they market the crap out of it, attract billions of dollars into it, then make money taking the opposite position while at the same time making money on loads, management fees, and commissions.  I'll leave the ethics of that too you, but if the company who designed it, takes very large positions against it regularly, that should tell you all you need to  know.

 

Again though, I can't emphasize enough, understand the risk involved in naked puts. 

where did you hear/read that Barclays is taking the opposite position? They might very well do not hedge all of the exposure they get from VXX but I doubt they leave any bigger position unhedged - while they'd earn the roll yield they also would expose themselves to a big spike in VIX. As you say they can just earn the fees risk free and I think that is the business model if you launch an ETN. They wouldn't need to have the biggest VIX based ETN on the market to be short VIX futures if they wanted that. And usually when markets tank and VIX spikes bank have a whole lot of other risks that go against them so it wouldn't be the best idea to double up on that and short some VIX futures.

 

I like the strategy you propose though and I've yet to compare that against being long inverse ETNs (like XIV) - something on my to do list - what sort of delta do you usually go for?

[PaulCao]

Hi All,

 

Thanks for everyone's sound advice.

 

Marco, I see your point now about how difficult it is to replicate VIX spot price. I thought I could get away with this problem by buying a DITM VIX *option* call, but the lowest strike price bin I can buy at is 9.00 and even there, the call price reflect the carrying cost of VIX futures. This is kind of obvious now that I think about the zero-arbitrage opportunity that could exist between selling VIX cash-settled options and VIX futures.

 

I looked into replicating VIX synthetically on my own; this is actually very difficult as SPX the underlying moves up and down, and there'll be tremendous dynamic hedging involved. And to be honest, I couldn't wrap my head around the math. (You have to keep a constant delta-neutral straddle and buy and sell VXX corresponding the vega of your straddle); and there's no free lunch, as you face theta decay.

 

I've settled on an easier way and much inefficient way of doing this, pair trading VXX and VXZ.

 

VXZ composes a rolling VIX futures three, four, five and five month out:

http://www.ipathetn.com/us/product/VXZ/#/dollarweights

 

Compared to VXX's rolling VIX futures one or two months,

 

Using Marco's VIX term structure, we can see that the contango is less on VXZ's components vs. VXX, so it should perform better, as one can seen; select any long-term period,

https://www.google.com/finance?q=vxx%2Cvxz&hl=en&ei=mqpdUYiCNqHL0AGpfg

 

I have executed to buy 1 VXZ call and sell 1 VXX call for test trade, will report with performance,

 

Best,

PC

[Marco]

Hi All,

 

Thanks for everyone's sound advice.

 

Marco, I see your point now about how difficult it is to replicate VIX spot price. I thought I could get away with this problem by buying a DITM VIX *option* call, but the lowest strike price bin I can buy at is 9.00 and even there, the call price reflect the carrying cost of VIX futures. This is kind of obvious now that I think about the zero-arbitrage opportunity that could exist between selling VIX cash-settled options and VIX futures.

 

a DITM option on VIX would be quite similar to a VIX future of that maturity - again you are not trading VIX spot.

 

I looked into replicating VIX synthetically on my own; this is actually very difficult as SPX the underlying moves up and down, and there'll be tremendous dynamic hedging involved. And to be honest, I couldn't wrap my head around the math. (You have to keep a constant delta-neutral straddle and buy and sell VXX corresponding the vega of your straddle); and there's no free lunch, as you face theta decay.

 

well you would need a basket of 1 months SPX options across various strikes (more puts than calls). As you say its impossible for a retail investor to achieve than and you then still have the theta - so I'm not sure whether thats cheaper than being long VIX futures.

 

I've settled on an easier way and much inefficient way of doing this, pair trading VXX and VXZ.

 

VXZ composes a rolling VIX futures three, four, five and five month out:

http://www.ipathetn.com/us/product/VXZ/#/dollarweights

 

Compared to VXX's rolling VIX futures one or two months,

 

Using Marco's VIX term structure, we can see that the contango is less on VXZ's components vs. VXX, so it should perform better, as one can seen; select any long-term period,

https://www.google.com/finance?q=vxx%2Cvxz&hl=en&ei=mqpdUYiCNqHL0AGpfg

 

I have executed to buy 1 VXZ call and sell 1 VXX call for test trade, will report with performance,

 

Best,

PC

this is somewhat similar to the VIX Call calendar that Kim did here. You are basically hoping for the term structure to steepen (front coming off more than the back end) which typically happens if VIX comes off. So you are bearish on VIX and bullish on the market taking that position. Contago works in your favor here as the front of the curve (VXX) will approach the spot faster than the back end so your VXX call has a higher chance of expiring worthless while the VXZ call still has some value. And you will likely loose money in any VIX spike when term structure flattens or even moves to backwardation.

I'm not sure what the benefit of playing this with VXX /VXZ vs.a VIX May/Aug or May/Sep Call calendar is though.

[cwelsh]

Some CNBC report in December had the Barclay's info.  But you can read about it in public documents as well:

 

Barclays, in the VXX PPM (well over 200 pages long BTW), they expressly disclose that their investment arm, barclays capital, inc. "may acquire a short position in the VXX ETN."

 

Go read the audited financials of Barclays capital, inc., they have HUGE short positions in the ETN's they trade (not surprising if you go read the returns on the ETNs they offer).

 

Basically, as far as I can tell, its a huge scam that nets them piles of money.  Basically:

 

1.  Offer ETN, charge fees to do it;

2.  Collect interest on ETN sales;

3.  Trade against ETNs at the same time you sell it to other because you know its going to decline in value.

 

I'm sure Barclay's would just say, because they are the market maker, they're hedging their position.  That's a load of BS.  Who in their right mind would continue offering an instrument that loses well north of 50% of its value EVERY YEAR?  If I was on a trading desk and designed a strategy to lose my customers over 50% of their money each  year, I'd be fired in 10 seconds -- unless the sale to my customers made my company millions.

 

Sorry if this sounds like conspiracy, but there's simply no way this type of thing should go on.

 

That said, as it makes me money each quarter, I don't know why I gripe.

[ykotowitz]

I like the strategy you propose though and I've yet to compare that against being long inverse ETNs (like XIV) - something on my to do list - what sort of delta do you usually go for?

 

Hi Chris

I am also curious about the comparison with XIV, or the more conservative ZIV.

Also, why a naked put rather than a spread? as you are mainly relying on the negative roll and limited gain?

[cwelsh]

Hi Chris

I am also curious about the comparison with XIV, or the more conservative ZIV.

Also, why a naked put rather than a spread? as you are mainly relying on the negative roll and limited gain?

 

You could do a spread, but that caps your gains, and as long dated as I go (typically 90 days), I want to be able to capture as much gain as possible, particularly in case if it ever does go against me.

 

And yes, I am primarily relying on the negative roll -- "relying" is a strong word though -- just go look at the chart.  Other than April 2010 (28% loss) and mid July 2011 (56% loss), there has never been a 90 day period that the VXX did not lose money.  Those are the WORST case possible results too -- requiring an enter on the absolute lowest spot VXX had been in a while and exiting at the highest. 

 

Average return? About 20% per month.  How do you do this?  Simple, buy 90 days out, as soon as you hit a 10% plus return, sell and roll to another 90 days out.  Frequently I'll wait for a small pop. For instance, I' just sold my September VXX puts today, after holding for less than a week, for a 16.9% gain.  I'll wait for a pop, then enter another 90 days out. 

 

As always, position sizing is key.  I'm fully expecting, sooner or later, a 20-40% negative hit.  But let's look at a $10K investment, assuming a fifty percent negative hit one month a year.  Even if I am only getting 10% per month, I end up WAY ahead.  11/12 months, I get $1,000.00.  One month I lose $5,000.  That's a net gain of $6,000 on a $10,000.00 investment -- or 60% on the year.  Even if I have TWO fifty percent losses on the year, I still break even.  (10/12 10% gains = $10K 2/12 50% losses = -$10K).  

 

And I've been averaging a LOT higher than 10% per month.  (Since I started doing this, I'm averaging 19% per month). 

 

Do I want to allocate more to this trade?  Sure it seems a GREAT idea to put 50% of my portfolio on it.  But I wont do that.  I NEVER allocate more than 10% of a portfolio to a trade.  And if you keep your position sizes constant, the surprise result doesn't hurt.  Heck, even if you had a 100% loss  one month, and a 10% gain the other 11 -- you STILL END UP AHEAD. 

 

This negative roll thing is great.

 

Again, if anyone sees problems with this, please let me know, I'm always interested in improving strategies.  For about the last nine months though, I feel like I'm shooting fish in a barrel. 

[Marco]

Chris what sort of delta (if any) do you target with these ITM puts?

thx.

m.

[ykotowitz]

Hi Chris,

Thanks for your reply. I can see that a spread will limit the gains too much on long dated options.

I am confused about the option length. Do you do 180 day (original note) or 90 day (your last response)?

?

[jfouche]

The weird thing is that there is no negative carry in the VXX option market -- synthetic prices in future months are pretty close to the current price. [For example, Sep 18 call - Sep18 put is $0.7 with the stock at $18.79].  So, someow it is easy to short VXX -- perhaps there are so many long holders that it never reaches hard-to-borrow status.

 

Although the puts work, if you are following premium-heavy strategies like SO, you can just short VXX and hold on as long as you feel like it. Periods like 4/2010 and 8/2011 would hurt, but you'd make it up from long gamma positions and a lot more.

[cwelsh]

I typically aim for 90 days, but have gone as long as 180 and as short as 25 -- depending on the purpose.

 

If I am JUST going to long put to capture the roll decay, I prefer 90 days;

If I am hedging on earnings trades (typically if I have 3-5 earnings trades on, I'll buy VXX puts as well to cover a decline in volatility as a whole which may impact the earnings trades), I use a shorter window, 25-30 days.

If I am rolling out because of an adverse move (so increasing position size), I'll use 120-180 days to give more time for the position to recover as necessary.

 

Hope that clears it up.

 

I'm pretty sure Kim is working on a piece on how to add this in to the SO profile -- I've sent him some of my notes and past trades, he'll probably do a clearer explanation .

[PaulCao]

Hi Guys, 

 

To revisit this topic, I still like the idea of replicating VIX and hedging it against a falling VXX. I was hoping the option experts here can tell me if there's anything wrong with my replicating strategy, 

 

So my plan is to re-create an imperfect but good enough VIX by buying a ATM SPY call, and making it delta-neutral by shorting the necessary underlying; and then hedging it in accordance to its vega in relations to VXX, 

 

Concrete example:

 

I first figure out the percentage increase of my SPY call if volatility increases 1%; I use an option calculator and given today's ATM option for SPY, the vega is 0.174 (the change in option price if volatility rises by 1%) and using the current option price, the 1% increase in volatility leads to 5.3% increase in option pricing; provided that the underlying remains flat and theta decay is zero. 

 

I then figure out the percentage increase of VXX if volatility or VIX increases 1%; this is tricky as VXX is a synthetic 30 day future of VIX. But for the sake of simplicity, I'll assume that it moves in lock-step with VIX (when in fact VXX usually trails VIX). the 1% increase in volatility here implies $1 change in VIX, or converted to VXX dollar-weight would imply a 4.5% increase in VXX. 

 

So now I have my ratio: 1 SPY call to 1.17 VXX. 

 

So I'd buy SPY calls one month out (to correspond to VXX's 1 month rolling future), and then sell 1 VXX ATM call. Then keep my SPY call delta-neutral by shorting the delta amount of underlying or better yet, just roll with a straddle in which case, my ratio would be

1 ATM SPY straddle to 2.34 VXX

 

and roll whenever the straddle is too far out of the tent. 

 

Obviously, there will be hedging cost as well as theta decay, but the straddle ratio would counter VXX spikes in case volatility suddenly spikes up. I'll try to execute this and report back with performance. 

 

Best,

PC

[Marco]

I'm curious how that goes. However I expect the theta to eat up any VXX gains. Also in theory you'll need to keep rolling your SPY hedge to have a maturity close to 1m for it to be anything like a hedge vs. your VXX position.

At the first glance I think you have too much VXX against your SPY so you might make money if vol comes off here and lose if it spikes further (depending on how all the other moving parts (theta, when you roll your SPY hedge etc) work out.

You are basically trying to be long vol for free (SPY) or short vol without risk (VXX) that's the trading equivalent of turning lead into gold or finding the perpetual motion machine.

[PaulCao]

Hi Marco, 

 

Thanks for your reply. I'll let you know how it goes. 

 

Right now, I have 1 straddle of 5/17 SPY at 155 against -3 VXX 4/26 call at 20 and 40 VXX stock; that way I match 1 SPY straddle against 2.6 VXX.

 

I'm also curious if I have the ratio of VXX correct. It's a little bit tricky as VXX is a rolling futures whose pricing takes into account the mean-reverting nature of VIX. At the moment, VIX spot falling 11.67% while VXX is down only 6.22%. So there'll definitely be gaps in tracking but I'm also betting over the long run, VXX will perform worse than VIX. The alternative is to sell VIX calls against my SPY straddle, but I like to try VXX first.

 

Currently, my position is down $9 over a margin of 1.87K. 

 

Best,

PC

Edited April 19, 2013 by PaulCao

[Kim]

I don't see how this strategy is better than what we are doing at SO portfolio. We are short volatility via VXX as well, but instead being long volatility via SPY where nothing prevents the theta losses, we are long volatility via earnings trades where theta is offset by IV increase caused by upcoming earnings. No matter how you look at it, the theta losses will be less with the earnings plays.

[Noah Katz]

Has anyone tried Chris' strategy and/or determined what its risk/reward profile is compared to the VXX weekly put diagonal?

[Noah Katz]

>  Buy DITM, far dated, VXX puts.

Chris, or anyone else who's doing this, how DITM, as a % of ATM?

[thesnaggle]

On 1/24/2017 at 8:53 PM, Noah Katz said:

>  Buy DITM, far dated, VXX puts.

Chris, or anyone else who's doing this, how DITM, as a % of ATM?

Funny how Chris' posts kinda died in 2013... maybe I'm missing something but do not see it carried on anywhere else... I really like the strategy and will be testing it in my portfolio.

Are you doing this as well @Noah Katz?

[Kim]

This is similar to what we do with VXX strategy.

[Noah Katz]

12 hours ago, thesnaggle said:

Are you doing this as well @Noah Katz?

 

Sort of; when Trump announced he's have a tax plan in a few weeks I figured the market was safe for a few weeks and bought a bunch of Mar17 $18 VXX puts

[FrankTheTank]

Is anyone still following this?  I was searching google for VXX pairs trade and this thread showed up.  Glad I was already a SO member so I can read it 

Quick backtest of buying 90 day VXX puts (no profit target)

http://tm.cmlviz.com/index.php?share_key=20180910232823_IX9wPyeTSfCBXXFq

 

Here is the same with a profit target of 40% and then re-open a new trade:

http://tm.cmlviz.com/index.php?share_key=20180910233237_8nfPTB3Lg2ZDnFD3

 

I dont like the way CML reports % return based on "amount risked" so instead I look at the dollar return for each option.   Seems like buying the 80 delta puts and holding for the entire 90 day window gave the highest dollar return over the past 5 years.  Unless I am reading this wrong which is possible.