VIX VXX Pairs Trade

[Davidkot81 11]

Possible VIX VXX pairs trade idea

Using options -- aim for PUT credit spreads for VIX 45 DTE, with the short ITM leg being at when OI of 1000 or more ideally but minimum of 7 strikes away from ATM, with long leg being 1 strike OTM.

For VXX, CALL credit spreads 45 DTE, with the short ITM leg ideally being at when OI at 500 or more, and also long leg 1 strike OTM.

Close out when +$450 or lose $1000 or more, or at 30 days.  Exception:  when in VX futures contango, and this shifts to backwardation, take advantage buy closing out 50%of max gains (which is about $5000 or so).

 

 

VIX always 10 contracts, make VXX notionally equivalent. ( I wanted to fix the buying power reduction total to $2400 but TOS is fritzing and making all prices NA when I try to change the # of contracts in VIX in think back for some reason... which is beyond frustrating!)

 

I have backtested and am attaching some data, with specific trades if you want to check my work.  Not 100% error free but tried to keep the strategy consistent.

 

 

 

 

[Edwin 63]

Thanks for offering up this strategy and posting backtesting results.

What do you do with VIX this low for short legs 7 strikes away from the money?

Any reason why you select VXX calls instead of trading VIX calls and VXX puts?  I'd think you'd want to trade VXX puts because of the negative contango drag, unless you think there will be prolonged backwardation in the term structure.  Does swapping to two make a difference in backtesting results?

[Davidkot81 11]

Hi Edwin, thanks for the reply.

I use  a larger spread because it improves the risk/reward for each instrument.  The downside is if there are losses due to illiquidity and slippage.  Because TOS was not working properly last night I couldn't factor slippage.  Real trading will be needed to see if these fill, and I've started trying to do this with 1 contract each.

For VXX I used a call credit spread which is neutral to bearish.  You're exaxtly right- that such a strategy should be able to help capture some of the contango loss and also the fees charged by the ETN holder.  I could buy a put in VXX and a call in VIX but this would lead to losses due to time decay and also lose money in neutral conditions.  Selling a spread can be profitable in neutral conditions and has minimal time decay or volatility effects.

[Yowster 8,047]

I'm a big fan of any trade structure based on the VXX falling with a hedge to protect against big market downturns.  So, I think if you backtest any trading model based on this premise over the last few years it's going to show really good results.   You are selling VXX call credit spreads - which under "normal" market conditions will do well because the VXX tends to fall both when the VIX is falling and also when the VIX is relatively stable.  Your hedge is selling the VIX put credit spread which will do very well if the market hits a downturn and VIX has a large spike.    Fundamentally, I think this is quite similar to buying VXX put  debit spreads or diagonals (Kim has done this a few times and you've likely read the thread on my weekly VXX put diagonals), and hedging with the SO VIX calendar strangle and/or buying OTM VXX calls or call debit spreads.    I'm not saying that one strategy is better than the other, only that I'm a big believer in any trade structure based on a falling VXX over time (with some sort of hedge to protect somewhat against big market downturns).

[Edwin 63]

5 hours ago, Davidkot81 said:

Hi Edwin, thanks for the reply.

I use  a larger spread because it improves the risk/reward for each instrument.  The downside is if there are losses due to illiquidity and slippage.  Because TOS was not working properly last night I couldn't factor slippage.  Real trading will be needed to see if these fill, and I've started trying to do this with 1 contract each.

For VXX I used a call credit spread which is neutral to bearish.  You're exaxtly right- that such a strategy should be able to help capture some of the contango loss and also the fees charged by the ETN holder.  I could buy a put in VXX and a call in VIX but this would lead to losses due to time decay and also lose money in neutral conditions.  Selling a spread can be profitable in neutral conditions and has minimal time decay or volatility effects.

Ok, sorry, when I read this, I missed "credit" spread.  For VXX what delta call would you be selling?  When going through your backtesting, it looks like your VXX spread width changed throughout, why was that?  Were you mainly looking at OI, and not deltas?

[Davidkot81 11]

That's right.  I was aiming to look at OIs so they would be more liquid.  

OI of 1000 in VIX and 500 in VXX were my goal OIs but not always achievable in VIX so I set a minimum of 7 strikes ITM for short leg and 1 strike OTM for long leg.

This was violated one time in the excel data above so will need to redo to check (one trade had vix at a tighter spread than 7 strikes).

when I redo the analysis I will also try to expand the VXX to two strikes more in the money prior to an OI of 500.

This strategy has to be replicated in real life to see if the liquity holds up.

Edwin- I believe we are on the same page.. Nice! My only caution would be to avoid VIX calendars at all costs... Tastytrade calls this the "death trade" as the losses can greatly exceed the debit paid.  For VXX  not an issue.

Edited August 8, 2016 by Davidkot81

[Kim 7,513]

14 hours ago, Davidkot81 said:

Edwin- I believe we are on the same page.. Nice! My only caution would be to avoid VIX calendars at all costs... Tastytrade calls this the "death trade" as the losses can greatly exceed the debit paid.  For VXX  not an issue.

We had very good success with VIX calendars overall. The key is not to hold them too long, so the negative gamma doesn't become too big. But I agree that you are not careful, losses can be significant.