Jill Malandrino, formerly of TheStreet.com writes it beautifully when she notes:
To see how often VIX futures are in contango, or more precisely, how often VXX falls, here is an all-time price chart for trading VXX options:
Yep, the VXX is down 99.96% since inception. The reason is simply that VIX is almost always in contango. For the times that VIX falls out of contango, we can see abrupt pops in the VXX which we have highlighted in the image above.
The Incredible Option Trade In VXX
in 2017, Ophir Gottlieb from CMLviz Trade Machine tested buying a put option spread in the VXX using the 90 day options over the last five-years. Here are the results of this VXX options trading strategy:
Tap Here to See the back-test
We see a 615% return, testing this over the last 5-years. Since we tested the 90 day options, that was 21 trades, in which 17 were winners and 4 were losers.
In fact, this strategy would be a winner every single year in 2010-2017.
2018 was very different
2018 was a very different year in many areas. In fact, 2018 was a first positive year for VXX since inception:
We tested the same VXX strategy in 2018. Here are the results:
Tap Here to See the back-test
That's right, for the first time since 2010, this strategy would produce negative returns. Which is not surprising, considering VXX was up 73.5% in 2018.
In fact, some periods in 2018 (specifically February and December) were so brutal that some funds blew up their clients account. The Spectacular Fall Of LJM Preservation And Growth describes one of those funds. Some of those funds were in business for over 20 years, but when volatility went through the roof in February, it was too much for them.
How to do it the right way
The way to create more consistent returns shorting volatility is to utilize spreads to hedge your position. At the simplest level, this modestly reduces profit potential but dramatically reduces loss potential. Even under the hedged scenario we can still create a 1:1 Risk:Reward on a trade that wins about 75% of the time. The key is when that wave of massive volatility hits the market seemingly overnight, we are dealing with a manageable loss rather than something catastrophic as one would expect in the unhedged scenario.
There are times where extreme volatility will give solid opportunity to short volatility unhedged, but it should always be done with a very small allocation. Patience and experience is also key with regard to entering, adjusting and exiting positions. In addition there are times where things get so out of touch with reality that the best course of action is to simply sit out for a bit and let the dust settle. It is likely that the most successful volatility traders use a combination of discretionary and systematic strategies in their trading.
Our PureVolatility portfolio (which is part of Creating Alpha service) produced double digit returns in 2018 during a first positive year for VXX since inception. Considering the overall market environment, this is an incredible performance.
The Incredible Winning Trade In SVXY describes one example of how the strategy performed in February when VIX doubled in a single day. Overall this trade produced almost 45% gain on margin or 26% gain on $10,000 portfolio.
A trade that was long SVXY, was a big winner after SVXY went down 90%+. This is options trading at its best. And this is the power of our trading community.
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,
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,
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,
for those who trade VIX - be it though futures, options or ETP's (VXX,XIV,ZIV and the like).
I came across a paper that I found very interesting - well I only glanced over it for now and read a few things in more detail, but it looks very interesting so far.
Trading VIX related strategies is slightly more complicated in my opinion that 'normal' option strategies, so if you are new to options and still get your head around delta,gamma,theta keep this for later and certainly venture into this area slowly and carefully. Having said this I think this is written not overly complicated and you don't need a degree in maths to understand it.
It also offers a number (5 to be precise) of actual trading strategies and compares them - so it's not only about theory.
At the first glance I particularly like these two (for simplicity and results):
#3-Roll Yield: if the 10 day moving average of VXV/VIX > 1 go long XIV else go long VXX #4-VRP: (volatility risk premium) if the 5 day moving average of (VIX - 10 day historical volatility) > 0 go long XIV else go long VXX I have heard of the first one before here (note this guy has the ratio the other way around). The results looks pretty good however I would caution that these reverse ETN's havent been around for too long yet (~2.5-3 yrs - so after the 2008 financial crisis) and trend in VIX was down over that time frame so a simply buy and hold would have been a pretty good investment as well. So the backtesting has to be seen in that context. A quick backtest since 30-Nov-10 (when XIV was listed) and I start with a long position in XIV on both: roll yield: 7(!) trades since inception, total (non compounded return (just adding % returns so +12%, +13%, -5% = +20%) = 296% (the strategy is long XIV since 12-Oct-11 without any trades since) VRP: 23 trades since inception, total return 153% buy and hold XIV since inception (30-Nov-10) 146% NB: I'm counting a flip from one ETN into the other as one trade. Backtesting has been done with EOD prices. I urge you to understand how VXX and XIV work and the risks involved before you actually try and trade this. Also read the paper (they mark the bits about risk with a 'grim reaper' ) okay here the paper and the link to the back testing sheet (let me know if you come across any errors). Marco. 00R_Easy Volatility Investing + Abstract - Tony Cooper.pdf https://dl.dropboxusercontent.com/u/26062189/XIV_VXX_strategies.xlsx
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