VIX ETP Seasonality: Days to Expiration

20141105.01This is a follow up to a post from the always excellent Trading the Odds showing that XIV (inverse VIX) is particularly strong (and VXX particularly weak) in the two days prior to VIX futures expiration, as futures are usually forced to converge down to the spot VIX as a result of VRP. I’ve shown TTO’s results to the right (click to zoom).

I have a slightly different take on the subject. XIV strength on those days isn’t, in and of itself, necessarily an important bit of data. Given the fact that we have limited VIX ETP history to consider (just over 10 years), it could be that, just by happenstance, equities were strong on those particular days and XIV was merely along for the ride.

A different approach would be to look at the daily excess return of XIV, above and beyond what we would expect given the day’s change in equities.

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In the graph above I’ve shown just that: the daily excess return in XIV by days to expiration.

I performed a simple linear regression between all available SPY (cash only) and XIV data, and calculated XIV’s average daily return in excess of that regression, for each day. The relationship between daily changes in SPY and XIV is not linear, but close enough for the purposes of this illustration.

Note the jump in excess return 1 and 2 days prior to expiration, confirming TTO’s original observation. To clarify, that doesn’t necessarily mean that those days were positive (or for example, that day 4 was negative), only that they tended to return more or less than one would expect given the day’s change in equities.

Just for fun, the following graph shows two hypothetical portfolios. The first (blue) only buys XIV 1 and 2 days prior to expiration, and the second (grey) buys XIV on all other days. All trades are close-to-close, and I’ve ignored transaction costs and slippage.

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The graphs shows that, to date, it’s been mostly smooth sailing for XIV 1 and 2 days before expiration. But, likely by pure happenstance, it’s also been smooth sailing for SPY on those days as well (not shown for the sake of brevity). So that means that those positive XIV returns in TTO’s data are partially a result of the excess return on those days that we’ve shown here, but it’s also likely partially because nothing particularly bad has happened to equities on those days either.

Wonk note: The observation discussed in this post is much less pronounced with ZIV/VXZ (mid-term VIX ETPs) because they’re based on futures that are further from expiration and thus are not forced to converge to the spot VIX while ZIV/VXZ holds them.

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

Good Trading,
Volatility Made Simple

VIX Trading: Trading the Odds’ VRP Strategy

This is a test of Trading the Odds’ Volatility Risk Premium (VRP) trading strategy (1). The strategy is very similar to the Brute Force VRP strategy we shared back in July, and compares the VIX spot to historical volatility to predict changes in VIX ETPs like XIV and VXX. Frank, the brain behind Trading the Odds, has been doing some excellent VIX trading research lately and I highly recommend the follow. It’s good to see more quantitative types talking about the subject.

Edit: see footnote re: difference between my results and those shown by Frank on his site.

Below are the results of TTO’s strategy in blue, versus the Brute Force VRP strategy we presented in grey, both trading XIV and VXX from 07/2004 to present. Read about test assumptions, or get help following this strategy.

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Strategy rules:

  • At the close, calculate the following: the 5-day average of the [VIX index – (2-day historical volatility of SPY * 100)]. Note that historical volatility is based on the natural log of each day’s % change.
  • Go long XIV at the close when the result of the above formula is greater than 1.25, otherwise go long VXX. Hold until a change in position.

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Regardless of any difference in the stats, these two strategies are so similar that I would be more or less equally confident in either strategy’s performance in the future. As with most trading strategies, the concept being exploited is much more important than the specific parameters chosen.

The differences between the two strategies follow:

  1. TTO’s strategy uses a 2-day standard deviation of SPY (as opposed to the Brute Force strategy’s 4-days). That shorter lookback is going to lead to much more volatile results for the standard deviation calculation, which is likely why this strategy trades nearly 3-times as often.
  2. Rather than using zero as the threshold for buying XIV vs VXX, TTO’s strategy uses what I assume was an optimized value of 1.25. That’s going to make the strategy slightly more likely to go long VIX (ex. long VXX). I don’t have an issue with that, but I might also caution about adding unnecessary extra parameters, unless it led to a large and consistent improvement in performance, as it implicitly increases the risk of curve-fitting results.

Again, as I’ve stressed repeatedly, the concepts being exploited are much more important than the specific parameters chosen. All sets of parameters will, over the long-term, rise or fall together based on the success or failure of the core concept. Here that concept is to compare the VIX spot to historical volatility to predict VIX ETP returns. This the third strategy we’ve covered that is exploiting this observation (the others being DDN’s VRP and our own Brute Force VRP).

Note that I don’t see this category of strategies as a panacea. Recent success hides the fact that for both 2012 and 2013, these strategies trailed buy & hold badly. I think a more holistic approach, that considers not just the concept presented here, but many of the other concepts we talk about here at VMS as well, will be the better play over the long-term.

Having said all of that, I think that there’s value in presenting divergent views, so when this strategy (like most we cover on this blog) signals a new trade, we’ll 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:

  • These type of strategies, comparing the VIX spot to historical volatility, have become known as “volatility risk premium” or VRP strategies. In truth, there are multiple VRPs in the VIX complex (VIX spot vs realized volatility, VIX futures vs realized VIX, etc.), so admittedly, the term is probably not the most accurate. In any case, we stick with that convention here.
  • There is a pretty significant difference between the results I’ve shown here and those shown on Frank’s site. After some quick analysis, it looks like Frank might have used the S&P 500 cash index (GSPC) as opposed to the non-dividend adjusted SPY. Why would there be such a large disparity in results using two such similar indices? To some degree, it’s likely the result of curve-fitting, especially bearing in mind that optimized 1.25 cutoff. That isn’t intended as an affront, as all backtests implicitly include some amount of curve-fitting. That also doesn’t mean using the cash index is or is not superior, only that the results are probably overly optimistic. In any case, I’ll be posting follow up results in the near future.

VIX Trading Strategies in October

We’ve tested 18 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.

October was a tough month for most of these strategies as a result of a VIX spike more significant than most, both on the way up and on the way down. Below I’ve shown the October and YTD results of the 18 strategies we’ve blogged about previously, trading XIV and VXX. Read about test assumptions or get help following these strategies.

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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

Far and away, the standout this month was our Brute Force VRP strategy, which called nearly every gyration of the market perfectly, and returned 81% for the month. I covered the strategy’s exceptional month in more detail here. As is often the case, I find myself being the killjoy and injecting a bit of “everybody calm down” into the discussion.

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).

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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

Optimized VRP Strategy Up 69% MTD

In July we shared a VIX trading strategy we called Brute Force Optimized VRP. It slayed the volatility dragon this month, calling every gyration of the VIX near perfectly, and gaining 69% MTD trading VXX and XIV. In this post, I want to talk a little more about that big 1-month return.

Below are strategy results so far in October. Read about test assumptions, or get help following this strategy.

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Read our original post for strategy rules. To understand how this strategy works conceptually, refer to Four Graphs to Rule Them All. Using the parlance established in that post, the strategy is using relationship #1 (VIX vs historical volatility) and its ability to predict relationship #2 (VIX vs future realized volatility), to hopefully (and more importantly) predict relationship #4 (VIX futures vs future realized VIX).

For a longer-term perspective, below are strategy results from 07/2004 to present:

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Seeing a one month result like 69%, especially out-of-sample, inevitably gets readers salivating, and that’s probably not completely unwarranted, but a healthy dose of reality is probably also in order.

I think the general concept employed by the strategy is definitely useful and is a concept that I use in our own trading, but I would caution about getting too excited about this particular variation of the strategy.

We track a lot of strategies here for subscribers, and when the VIX complex is making the type of wild swings is has this month, inevitably something is going to get it just right.

Recall that this optimized strategy we shared was based on a similar strategy from Double Digit Numerics. That strategy has not fared nearly as well this month, returning -10%, but I stand by my conclusion from our original post that over the long-term, either variation of the strategy will likely be as good as the other in the future, and the strategy as originally presented by DDN is probably very close to optimal. As with most trading strategies, the concept being exploited is much more important than the specific parameters chosen.

Having said all of that, I think that there’s value in presenting divergent views, so when this strategy (like most we cover on this blog) signals a new trade, 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

Evolution Capital’s VIX Trading Strategy

This is a test of the combined VIX ETP trading strategy from Evolution Capital’s paper Volatility: A New Return Driver? We’ve covered parts of the paper previously here and here. Strategy results from 07/2004 follow.

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Read about test assumptions, or get help following this strategy. Strategy rules:

  • Go long VXX (long VIX) at the close when the VIX will close above the front month VIX futures contract, and the front month will close above the second month (VIX > VX1 > VX2).
  • Go long XIV (inverse VIX) at the close when the VIX will close below the front month VIX futures contract, the front month will close below the second month, and the current roll yield is greater than the 20-day average of the roll yield (VIX < VX1 < VX2 and RY > 20-day RY).
  • Hold positions until any of the above conditions are not met. Also, move to cash at the close for a day whenever the following special condition is met: the strategy is signaling a long XIV position, but both SPY and the front month contract close up on the day (something that usually doesn’t happen as they tend to move opposite one another).

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We’ve covered components of the strategy previously (the VXX component here, and the XIV component here), and I suggest reading those posts for more thoughts on the individual parts of the strategy.

This strategy is similar to others we’ve covered, such as comparing the VIX vs front month futures and front vs second month futures. Evolution Capital’s unique additions are: (1) comparing the current roll yield versus its recent average, which as we’ve discussed previously, might be useful to traders concerned with reducing their time in the market, and (2) the special condition that triggers when both SPY and the front month contract close up.

That special condition would have changed this strategy’s position on just 63 trading days. And while those 63 days have been flat for XIV, I don’t know that we can draw too strong a conclusion about the usefulness of the rule based on so few observations.

All in all, I think that strategies like this one that compare various data points from the VIX complex, do have value in the VIX trader’s toolbox.

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A big thank you to Evolution Capital for posting their paper.

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 note: Data prior to the launch of XIV and VXX has been simulated. 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.