VRP and Other Measures of Implied Volatility from Trading the Odds

This is a follow up to the posts here and here from the always excellent Trading the Odds. We’ve covered TTO’s work previously when we looked at their variation of a “VRP” strategy, comparing implied vs historical volatility to trade VIX ETPs like XIV and VXX.

In these new posts, TTO looked at other measures of implied volatility beyond just the VIX index. We put these other measures to the test here. Strategy results from 07/2004 trading XIV (inverse VIX) and VXX (long VIX) follow. Read about test assumptions, or get help following this strategy.


There are four equity curves in blue in the graph above, versus buying and holding XIV in grey. I’ve intentionally painted them all the same color (more on why in a moment). But first, the strategy rules as tested:

  • At the close, calculate the following: the 5-day average of [implied volatility – (2-day historical volatility of SPY * 100)].
  • Each of the equity curves above uses a different measure for “implied volatility”: the VIX index, the 30-day constant maturity price of VIX futures, or VXMT (mid-term VIX) (1). I’ve also added the VXV index for good measure.
  • Go long XIV at the close when the result of the above formula is greater than zero (i.e. a premium exists between implied and historical volatility), otherwise go long VXX. Hold until a change in position.

Note that our results differ significantly from TTO’s. See footnote for a discussion of why.


I painted all four equity curves blue to drive home the point that, regardless of any perceived difference, these strategies have performed so similarly that any advantage of one over the others is likely the result of random chance. I would be about equally confident in any of these strategies moving forward.

All four variations were in agreement on about 96% of days. That’s because there’s very little information contained in any one of these measures that’s not also contained in the others.

30-day futures will tend to price higher than the VIX index, VXV higher than futures, and VXMT higher than VXV, simply because they’re measuring implied volatility further out (which adds to uncertainty, which tends to increase required risk premium).

Contrary to my first thought though, that doesn’t mean that longer-dated implied volatility spends significantly more time short the VIX (ex. long XIV). I’m assuming that’s because these type of strategies tend to only take a long vol position when volatility spikes, which is also when the premium between longer and shorter-dated implied vol is compressing, meaning that when it actually counts, using shorter-dated implied vol (like the VIX) doesn’t result in significantly different results than longer-dated vol (like VXMT).

In short, one of these four variations will outperform in the future just by happenstance, but I don’t think history offers a useful enough guide as to which variation that will be. I’d be about equally confident in any of these variations in the future.

A big thank you to Trading the Odds for the thoughts and allowing us to add our two cents here.

* * *

When the strategies that we cover on our blog (including this one) signal new trades, we include an alert on the daily report sent to subscribers. This is completely unrelated to our own strategy’s signal; it just serves to add a little color to the daily report and allows subscribers to see what other quantitative strategies are saying about the market.

Click to see Volatility Made Simple’s own elegant solution to the VIX ETP puzzle.

Good Trading,
Volatility Made Simple

Wonk notes:

  1. For all dates prior to 2008, the VIX index was used in place of the VXMT index.
  2. The results of our tests are significantly worse than those presented by TTO. The biggest reason is that TTO uses the S&P 500 cash index (GSPC), while I use the non-dividend adjusted S&P 500 ETF SPY, to calculate historical volatility. I can find no empirically-sound reason why using one index in place of the other should lead to such starkly different results, so I chalk most of the performance difference up to overfitting. That isn’t intended as a gotcha, as all backtests are inherently overfit to some degree. And it isn’t to say that GSPC or SPY is better or worse than the other. It’s only to say that if I were to use GSPC here, the sole purpose would be to produce a better looking backtest, so I’m sticking with the convention that I’ve used historically on this blog.

VIX Trading in 2014 in Four Graphs

VRP Explained 2Simply looking at a graph of a VIX ETP like VXX or XIV doesn’t tell us much about the underlying forces at play in the VIX complex. ETP prices are merely the end result of the relationship between these underlying forces (which is why traders shouldn’t rely too heavily on price to guide trades, the way one might with say a stock index).

In the next four graphs, I show how four of these key relationships played out in 2014. These relationships are numbered 1-4 in the image to the right, which shows how volatility, the VIX, and VIX futures are most commonly aligned.

Long-time readers will note that these are the same four I covered in Four Graphs to Rule Them All as far back as 1986. Note that I’ve also included YTD data for 2015 to capture our most recent VIX spike.


Historical volatility (shown here in grey as the S&P 500’s 10-day annualized standard deviation) is running hot at the moment, currently in the top third of readings since the VIX’s inception. The most recent uptick in HV is the result of two big up days for the equity market, hence the reason you see the VIX falling in response.



VIX futures behaved mostly as you’d expect in 2014 relative to the spot VIX. There was a fairly constant premium over the spot during periods of market calm (i.e. contango), and futures trailed the spot during significant spikes (i.e. backwardation, betting on mean-reversion to pull the spot VIX down).


As I noted in Four Graphs to Rule Them All, as you move from graph #1 to graph #4, the relationships illustrated become more and more important, but less and less consistent and/or predictable.

The fourth graph, VIX futures vs the future realized VIX, is really the key to the VIX trading game. Short-term VIX ETPs like XIV and VXX (for example) are perpetually shifting towards the second month contract to maintain a 30-day constant maturity. As long as futures are consistently overestimating the subsequent realized VIX, there will be money to be had in this trade as VIX futures are forced to converge to the VIX spot as they approach expiration.

The VIX complex did a very bad job in the second half of the year predicting the future as it failed to maintain a consistent premium (or discount for that matter) between futures and the subsequent realized VIX. As this is ostensibly a forward-looking relationship (futures today versus the spot in the future), I chalk that failure up to “stuff happens” rather than any fundamental shift in the VIX complex.

Where do we stand now? Despite VIX futures coming down from their recent highs, futures are still higher than about 80% of VIX spot readings since the current bull run began in late-2011, and higher than 90% of spot readings in 2014/15. That means that, if this market can continue to remain reasonably calm, there’s plenty of room for futures to fall, and XIV/ZIV to rise.

Having said that, in the back of VIX traders’ minds should always be the fact that at some point the low volatility regime of the last few years will come to an end. VIX futures are very much average at the moment relative to the entire history of the VIX spot.

Click to see Volatility Made Simple’s own elegant solution to the VIX ETP puzzle.

Good Trading,
Volatility Made Simple

VIX Spikes Were Uber Common in 2014

This is a follow up to a piece from the always excellent VIX & More: 2014 Had Third Highest Number of 20% VIX Spikes. V&M finds, as the title suggests, that 2014 exhibited the third most 1-day VIX spikes of at least 20% since 1990.

In this post I look at a different definition of VIX spikes that takes multi-day spikes into account: VIX closes of at least 20% above a 10-day moving average (*). I’ve used this criteria in the past (read more and more), and while it results in about the same number of spikes as V&M’s data, it also captures big moves where no one single day might have met V&M’s threshold.


The blue bars represent the number of spikes, and the grey area the median value for the VIX during that year. Note that I’ve extended the data back to 1986 using VXO prior to the launch of the VIX.

Since 2006, there has been an uptick in the number of VIX spikes. 2014 ranked second amongst all years with 5 significant spikes, despite a median VIX value near the lowest seen in the VIX’s history. Note that the market has had similar years with a high number of spikes despite a tepid VIX in 1993, 1994 and 2006.

Contrary to conventional wisdom, the VIX has actually been less “spiky” during higher VIX years. That’s partially because it’s easier for a market event to shock the volatility market when the VIX is depressed and complacent rather than already elevated and cautious, and partially due to the fact that high VIX years were more likely to have one major spike that lasted a long time (rather than a series of smaller spikes).

Note that similar results were seen in V&M’s data, and similar conclusions would have been drawn had we used other variables for calling a VIX spike other than 20% above the 10-day MA.

Was 2014 significant in terms of the number of VIX spikes? Significant yes, but not so far outside of expectations that I think it necessarily says anything about the future. What’s more concerning for me is just the general increase in the market’s tendency to spike since 2006 and whether we continue to see that increase in the future.

Good Trading,
Volatility Made Simple

Wonk note: To control for overlapping VIX spikes, I required that after the VIX rose at least 20% above its 10-day average, it had to then fall back below its 10-day average before it could then register a new spike.

VIX Trading Strategies in December

We’ve tested 21 simple strategies for trading VIX ETPs on this blog (separate and unrelated to our own strategy). And while I can’t speak for all traders, based on all of my readings both academic and in the blogosphere, the strategies we’ve tested are broadly representative of how the vast majority of traders are timing these products.

All but but a handful of these strategies got walloped in December following significant losses in inverse VIX ETPs like XIV and ZIV. Below I’ve shown the December and 2014 results of the 21 strategies we’ve blogged about previously, trading short-term VIX ETPs. Read about test assumptions or get help following these strategies.



Stategies included in this report: First vs Second Month Futures, VIX vs Front Month Futures, VIX vs 1-Month Constant Maturity, VIX vs VXV Indices, V&M’s VIX:VXV Ratio, TM’s RSI(2)DFTB’s StDev Strategy, DFTB’s Spread Strategy, DDN’s Momentum Rotation, DDN’s VRP Strategy, 10/100-Day MA Crossovers, TWP’s Quadratic Fit, NAS’s VIX Futures Momentum, S&P 500 50/200-Day Crossovers, Brute Force Optimized VRP, LI’s Bollinger Band Strategy, LI’s SMA Crossovers, Evolution Capital Strategy, TTO’s VRP Strategy, MS’s Mean-Reversion, Macro Investor Strategy

The Revised TM RSI(2) strategy, a short-term mean-reversion model that spends very little time in the market, was the top performer for the month and the most consistent performer of the year.

The standouts for the year in terms of terminal return were clearly the “VRP” strategies tested here and here with YTD returns of 34% and 68% respectively. As I’ve cautioned many times however, when tracking as many different strategies as we track, trading vehicles as volatile as VIX ETPs, something is bound to appear to have the hot hand at any given moment. Whether or not this is a result of real predictive ability or just the luck of the draw is open to interpretation, but what I do know (and I’ve shown quantitatively here and here) is that chasing the most recent top performer is generally a bad idea.

The strategies that are leading the pack today very often find themselves at the back of the pack tomorrow. These VRP strategies are a good example of that. Despite their strong performance this year, both trailed buy & hold badly for all of 2012 and 2013. That’s why I always advocate for a more holistic approach that considers many of the different concepts we’ve discussed on this blog rather than marrying any one single idea.

XIV and VXX are of course not the only show in town. Below I’ve rerun the same tests, this time applying each strategy to the less popular (or is it “underutilized”?) mid-term VIX ETPs ZIV and VXZ (click to zoom).

20150104.03     20150104.04

Note that when any of these strategies signal new trades, we include an alert on the daily report sent to subscribers. This is completely unrelated to our own strategy; it just serves to add a little color to our daily report and allows subscribers to see what other quantitative strategies are saying about the market.

Good Trading,
Volatility Made Simple

TradingMarkets.com’s RSI(2) Strategy Signaling Bounce

Friday’s selloff pushed the (modified) TradingMarkets.com RSI(2) strategy to 100% long inverse VIX ETPs (like XIV or ZIV). I mention it here because it happens so infrequently, accompanying only the most overbought VIX. Even though the strategy is in the market about 30 days out of the year, it’s 100% inverse VIX only 5 days a year.

This is a short-term mean-reversion play betting on a falling VIX. 83% of these full allocation trades have been profitable. This is at least one positive sign for the coming 1-3 days.


Above are strategy results trading XIV from mid-2004 to present (read about test assumptions). Results for the entire strategy are in grey, versus results only when the strategy is 100% long XIV in blue. The strategy hasn’t been fully allocated often, but when it has, it has tended to be right.

When the strategies that we cover on our blog (including this one) signal new trades, we include an alert on the daily report sent to subscribers. This is completely unrelated to our own strategy’s signal; it just serves to add a little color to the daily report and allows subscribers to see what other quantitative strategies are saying about the market.

Click to see Volatility Made Simple’s own elegant solution to the VIX ETP puzzle.

Good Trading,
Volatility Made Simple