We’ve tested 24 simple strategies for trading VIX ETPs on this blog (separate and unrelated to our own strategy). And while I can’t speak for all traders, based on all of my readings both academic and in the blogosphere, the strategies we’ve tested are broadly representative of how the vast majority of traders are timing these products.
There was a huge disparity in the performance of those strategies in August, based on how each responded to the month’s massive VIX spike. Those strategies that moved to a defensive position (cash or long vol) early, performed well, and those that didn’t got hammered. Below I’ve shown the August results of all 24 strategies we’ve blogged about previously, trading the short-term VIX ETPs XIV and VXX. Read about test assumptions or get help following these strategies.
See the end of this post for links to all of the strategies included in this report.
There were two significant points of difference between the winning and losing strategies.
The four popular “VRP” strategies, all based on comparing historical volatility versus implied volatility, performed poorly. Implied vol (ex. the VIX spot) remained higher than historical vol (by most measures) throughout the crisis, meaning all remained stubbornly short the VIX.
Most of the remaining strategies are based on comparing two or more data points across the VIX complex, such as VIX futures, the spot, or other measures of implied vol such as the VXV or VXMT indices.
Those strategies that simply take a snapshot of those data points today, without smoothing (say, through a moving average or the like), tended to perform very well, because they turned defensive quickly when the VIX complex turned backwardated. Examples include strategies comparing the VIX vs VXV, 1-month CM, or front month futures.
Strategies that smoothed those data points tended to perform less well, as they were slower to react to the crisis. Here’s the rub though. Though smoothing worked poorly here, it has been the better approach historically. The VIX complex often turns backwardated for a brief period, but due to the mean-reverting nature of the VIX, it’s almost always a head fake. Smoothing has historically led to better risk-adjusted performance, because it’s prevented strategies from getting fooled by those brief spikes. That clearly wasn’t the case in August due to the speed with which this crisis came on.
Our own strategy performed poorly for the month due to both issues above. Comparing historical vs implied volatility is a big part of our trading, and we smooth observations of the VIX complex to prevent whipsaws. Historically that’s done well for us. Not so much in this crisis.
XIV and VXX are of course not the only show in town. Below I’ve rerun the same tests, this time applying each strategy to the less popular (or is it “underutilized”?) mid-term VIX ETPs ZIV and VXZ (click to zoom).
Note that when any of these strategies signal new trades, we include an alert on the daily report sent to subscribers. This is completely unrelated to our own strategy; it just serves to add a little color to our daily report and allows subscribers to see what other quantitative strategies are saying about the market.
Volatility Made Simple
Stategies included in this report: First vs Second Month Futures, VIX vs Front Month Futures, VIX vs 1-Month Constant Maturity, VIX vs VXV Indices, V&M’s VIX:VXV Ratio, TM’s RSI(2), DFTB’s StDev Strategy, DFTB’s Spread Strategy, DDN’s Momentum Rotation, DDN’s VRP Strategy, 10/100-Day MA Crossovers, TWP’s Quadratic Fit, NAS’s VIX Futures Momentum, S&P 500 50/200-Day Crossovers, Brute Force Optimized VRP, LI’s Bollinger Band Strategy, LI’s SMA Crossovers, Evolution Capital Strategy, TTO’s VRP Strategy, MS’s Mean-Reversion, Macro Investor Strategy, QT’s VXV:VXMT Strategy, TTO’s Optimized VRP, Godot’s Mojito 3.0