Backtest: Don’t Fear the Bear’s StDev Model

This is a test of Don’t Fear the Bear’s StDev Model for trading VIX ETPs like XIV and VXX. This strategy is of the slower-moving variety, averaging less than five trades a year. It spends 89% of days in XIV (inverse volatility), but shifts to VXX (long volatility) when volatility rises above a certain threshold.

Strategy results from mid-2004 to present:

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Strategy rules:

Go long VXX at the close when the 10-day standard deviation of daily % changes in the VIX index rises above 11%. Hold VXX until the 10-day standard deviation falls below 10%. Invest in XIV when not invested in VXX.

Wonk notes: Transaction costs and slippage are assumed to total 0.1% of each trade (0.2% round-trip). Return on cash has been ignored. Data prior to the launch of each ETP has been simulated back to 2004. We’re able to do this accurately using a combination of the indices and the futures data on which these ETPs are based. Read more about simulating data for VIX ETPs.

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As with all VIX ETP strategies (including our own), a dash of extra skepticism of results is warranted given how little data (< 11 years) and how few trades we have to consider, but to date, backtested performance has been strong. Note the significant underperformance over the last 1+ year; this will be something to monitor moving forward.

If I had to pick on something, it would be the use of a plain vanilla standard deviation measurement. Conceptually, I don’t like the idea of some random trading day 2 weeks ago being as important as today was in deciding whether I should enter a trade. I would much prefer to see something like a weighted standard deviation used.

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A big thank you to Don’t Fear the Bear for sharing this strategy.

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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 and separate from our own strategy’s signal; it just serves to add a little color to the daily report and allow 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

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

Yesterday’s selloff triggered the RSI(2) strategy from our previous post at the close, long 1/6 (17%) XIV. An additional down day in XIV will trigger an increase in position size to 50%.

I mention it here because we just recently tested the strategy. Recall the backtested results from our previous post:

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There are relatively few trades to consider, but so far this strategy has done a good job picking short-term bottoms in XIV and other inverse VIX ETPs (but my misgivings re: trading VIX ETPs using a Martingale strategy most definitely apply).

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 and separate from our own strategy’s signal; it just serves to add a little color to the daily report and allow subscribers to see what other quantitative strategies are saying about the market.

Good Trading,
Volatility Made Simple

A Twist on TradingMarkets.com’s RSI(2) Strategy

This is a twist on a VIX ETP strategy originally proposed by Trading Markets, and further tested by MarketSci. It is a Martingale-like strategy where the trader takes a position in XIV (inverse VIX) when volatility becomes overbought, and then progressively increases position size if volatility continues to rise.

Strategy results, based on TradingMarkets.com’s original strategy, trading XIV from mid-2004 to present:

20140308.01

Original strategy rules (1):

Divide the portfolio into 6 equal units. Buy 1 unit at the close if the RSI(2) of XIV closes below 10. Add 2 additional units if XIV closes below your entry price at any point. Add a final 3 units if XIV closes below your second entry price at any point. Close all positions when RSI(2) closes above 50.

Wonk notes: Transaction costs and slippage are assumed to total 0.1% of each trade (0.2% round-trip). Return on cash has been ignored. Data prior to the launch of each ETP has been simulated back to 2004. We’re able to do this accurately using a combination of the indices and the futures data on which these ETPs are based. Read more about simulating data for VIX ETPs.

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The strategy spends little time in the market, but has produced mostly consistent results. The problem lies in those nasty drawdowns during the 2007/08 crash. These types of catastrophic events are of course the bane of a Martingale-like strategy.

But VIX futures during the 2007/08 crash were often strongly backwardated (favoring VXX, not XIV), meaning any long XIV position at that moment would have been extremely risky.

So in this twist to TM’s strategy, we test only trading XIV when the VIX futures term-structure agrees with the trade (i.e. is in contango). Results of this revised test are in orange, versus the original strategy in blue.

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The revised strategy preserved most of the original strategy’s gains, while sidestepping the worst of the drawdowns. Again, most of the original strategy’s biggest losses came during periods of strong backwardation where the trader should logically have been wary about putting on a position in XIV, so despite a small sample size, I think the twist shown here has wings.

I’m using our own internal metrics to judge the state of the VIX futures term-structure, but results that are similar in spirit to these would be had using even simple approaches like the one covered in our previous post.

I present this test for discussion’s sake, but personally speaking, the idea of trading a Martingale-like system on something as volatile and potentially dangerous as VIX ETPs, makes me terribly nervous. These products can move against us very quickly, and I think, over the long-term, we’re better served looking to reduce position size as trades move against us rather than increasing it.

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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 and separate from our own strategy’s signal; it just serves to add a little color to the daily report and allow 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


(1) In TradingMarket.com’s original post, they shorted VXX when the RSI(2) of VXX closed above 90. In the real world, shorting VXX can be unreliable, so I’ve flipped the strategy on its head and assumed we went long XIV when the RSI(2) of XIV closed below 10. These are essentially the same strategy, with our version being easier to actually execute.

Backtest: Comparing First and Second Month VIX Futures

This is a test of a common strategy for trading VIX ETPs like XIV and VXX: comparing first and second month VIX futures. Traders often use this simple approach to determine whether the VIX futures term-structure is in contango (favoring XIV) or backwardation (favoring VXX).

Strategy results trading XIV and VXX are in blue, compared to buying and holding XIV, from mid-2004 to present.

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Strategy rules:

Go long XIV (VXX) at today’s close when the front month VIX futures contract will close below (above) the second month. Hold until a change in position.

Wonk notes: Transaction costs and slippage are assumed to total 0.1% of each trade (0.2% round-trip). Return on cash has been ignored. Data prior to the launch of each ETP has been simulated back to 2004. We’re able to do this accurately using a combination of the indices and the futures data on which these ETPs are based. Read more about simulating data for VIX ETPs.

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Were it not for the 2007/08 market crash, a case could be made that this strategy has been successful. In terms of terminal wealth, the strategy would have posted big returns to the tune of about 46% annualized, but the strategy failed so miserably in the 2007/08 crash that no reasonable investor would have stayed the course and I put little faith in the strategy navigating the next market crises.

Why the 2007/08 failure? As the next graph shows, front month VIX futures remained below second month VIX futures for most of the first part of the 2007/08 crash in XIV, and then were schizophrenic (and repeatedly on the wrong side of things) until late 2008.

XIV is in blue (left scale) and the difference between first and second month VIX futures is in grey (right scale, negative values indicate contango).

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For the sake of completeness, a drawdown curve (also known as an underwater equity curve), as well as monthly/annual returns for the strategy follow. Note too how the strategy has significantly underperformed XIV over the last 1+ year.

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In future posts we’ll continue to cover other common approaches to trading VIX ETPs. Click to see Volatility Made Simple’s own elegant solution to the VIX ETP puzzle.

Good Trading,
Volatility Made Simple