This is a follow up to a subject often covered by one of my favorite bloggers, Adam Warner:
How do VIX ETPs perform after VIX “pops” (or spikes)?
Adam’s criteria for a VIX “pop” is a VIX close at least 20% above its 10-day moving average, which occurs a little more than three times a year (1). Many investors see these pops as a signal to buy volatility (ex. VXX or VXZ), but history shows that unless you’re already positioned for the pop before it happens, or the market goes on to crash in grand fashion (ex. 2007/08), buying volatility in the face of such pops is likely a very bad idea.
Below I’ve shown the results of holding VXX for one month (blue) or one week (grey) following a VIX pop (1).
With just a handful of exceptions, going long volatility after a VIX pop has been a very bad idea.
This is a result of mean-reversion in the underlying VIX index itself, and not because of contango or a volatility risk premium or the like. To illustrate, below I’ve shown the same two hypothetical portfolios, this time assuming we bought the VIX spot index rather than VXX, since 1990 (of course we can’t actually buy the VIX index, this is just meant to demonstrate a point).
Because these two portfolios are falling with even more consistency than we saw in the first graph, we know that the results in the first graph are due to mean-reversion in the spot index.
Read more about the two forces acting on VIX ETPs.
* * *
Note that the point of this post isn’t to say that it’s never the right time to go long volatility. To the contrary, we occasionally go long vol in our own strategy. The point of this post is simply to say that, contrary to popular belief, a pop in the VIX is not in and of itself a reason to go long volatility.
A big thank you to Adam Warner for the always interesting thoughts.
Volatility Made Simple
Wonk note: to control for overlapping VIX pops, I required that after the VIX rose 20% above its 10-day average, it had to then fall back below its 10-day average before it could register a new pop.