VIX & More’s VIX:VXV Ratio

In our previous post, we looked at a simple strategy for trading VIX ETPs: comparing the VIX index to the longer-dated VXV index.

Recall these original strategy results trading XIV (inverse volatility) and VXX (long volatility) in blue, compared to buying and holding XIV in grey, from mid-2004 to present:

20140327.01

This original strategy went long XIV at the close when the VIX index closed below the VXV index, or long VXX when it closed above. Put another way, it went long XIV when the VIX:VXV ratio was < 1, or long VXX when the ratio was > 1 (read about test assumptions).

Bloggers VIX & More and Six Figure Investing have previously suggested only trading when the VIX:VXV ratio was sufficiently high or low, and remaining in cash when the ratio was middling. Both have suggested a ratio in the vicinity of 0.92/1.08 as better thresholds (i.e. long XIV when ratio < 0.92, long VXX when ratio > 1.08).

Below we look at how various thresholds like these have performed trading XIV/VXX from mid-2004 to present:

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There is a nice bump in risk-adjusted performance (ex. Sharpe/UPI) right around the suggested 0.92/1.08 threshold.

How much of this particular combination’s predictive ability is real and how much is overfitting the limited data is debatable, but just eyeballing an equity curve, the concept appears to have been consistently effective in reducing volatility/drawdowns without significantly sacrificing returns.

To illustrate, below is the original strategy in blue, versus the same strategy using the new 0.92/1.08 thresholds in orange, from mid-2004 to present:

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Again, note the consistent reduction in volatility/drawdowns without significantly sacrificing returns (with the exception of the 2007/08 bear market when the strategy, like many of these simple term-structure-based strategies, went off the rails).

A big thank you to VIX & More and Six Figure Investing for publicly posted these ideas. As VIX & More discusses here, the VIX:VXV ratio might be more productive when thought of in relative terms rather than in absolute terms as we have here, and in a future post we’ll dig deeper into that idea.

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Good Trading,
Volatility Made Simple

Posted in Strategy Backtests.