Following the Trend in VIX ETPs

Most commonly-cited approaches for trading VIX ETPs like XIV and VXX, are not based on the price of the ETPs themselves. Rather, they’re based on some other metric that gives insight into the inner workings of the ETP. Examples we’ve tested on this blog include analyzing the futures term-structure and estimating the volatility risk premium.

I’m a proponent of that sort of thinking, but there might also be a place for plain ol’ technical analysis as well. To illustrate, below I’ve shown the result of a 10/100-day simple moving average crossover strategy trading XIV (blue), versus buying and holding XIV (grey), since mid-2004.

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Trading rules:

  • Go long XIV at the close when the 10-day simple moving average (SMA) of XIV will close above the 100-day SMA, or move to cash when it will close below. Hold until a change in position.
  • Read about test assumptions (1). Get help following this strategy.

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The 10/100-day combination was an entirely overfitted choice for sure, but the tables below show that a broad selection of moving average combinations all show an improvement over straight buy and hold.

The table to the left shows the Sharpe Ratio, and the table to the right the Ulcer Performance Index, for many often used MA combinations:

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I ran this test only trading XIV (inverse volatility) and moving to cash following a cross under, rather than switching between XIV and VXX (long volatility). That’s because this most closely matches how most technicians interpret MA crossovers when trading equities. Crossovers tend to be bullish for equities (and by extension, bullish for inverse volatility), but crossunders are not necessarily bearish.

Had we traded both XIV and VXX it would looks as follows (original XIV-only in blue, XIV/VXX in orange):

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Like all of the simple strategies we test on this blog, I don’t think that moving average crossovers are sufficiently predictive to be a good strategy on their own, but I do think they make a useful component of a broader, more complete approach.

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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 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

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(1) Wonk note: At the start of this test there was insufficient data immediately available to create a full 100-day moving average (the test begins on day 67 of the data). In this case, we use as much data as is available for creating the MA. Because the sample starts in a strong uptrend, this should not significantly impact results. We’ve done this in order to start this test in 07/2004, the start date for most of the backtests you’ll find on this site.

Posted in Strategy Backtests.