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.
- 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).
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.
* * *
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.
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.