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.
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:
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.
Volatility Made Simple