This is a test of Don’t Fear the Bear’s Spread Model for trading VIX ETPs like XIV and VXX (see our previous test of another DFTB strategy: the StDev Model). The strategy works by comparing first and second month VIX futures (much like this strategy) but moves to cash when the VIX futures term structure is too flat.
Results trading XIV (inverse volatility) and VXX (long volatility), versus buying and holding XIV, from mid-2004:
Strategy rules: go long VXX (XIV) at the close when the 20-day average of the VIX futures front month premium is greater than 5% (less than -5%), otherwise to cash. Read about test assumptions.
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This strategy did a good job navigating the 2007/08 bear market, when the front month premium was schizophrenic (read more), by staying mostly out of the market. This is the advantage of not trading when the term-structure has been too flat to signal a clear bias.
The disadvantage can been seen in how poorly the strategy has performed over the last 1+ year, as the term-structure has often become too flat to signal a trade despite XIV’s strong performance.
Worthwhile variations on this strategy might include reducing the threshold for signaling a trade from +/- 5% to something less, or reducing exposure to XIV/VXX when the term-structure is flat, rather than moving entirely to cash.
Another big thank you to Don’t Fear the Bear for publicly posting this strategy and allowing us to put it to the test.
Click to see Volatility Made Simple’s own elegant solution to the VIX ETP puzzle.
Volatility Made Simple