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Tuesday, December 7, 2010

VIX buy & hold strategy

Here is a simple buy&hold strategy that popped up while I was playing with  some VIX based ETNs . The volatility was extremely high through the end 2008- beginning 2009, presenting a good opportunity to go short on the VIX. A good way to go was probably the  VXX etn, however one would suffer some substantial losses through the summer of 2010.
Now take a look what happens if the upside risk of the VXX (short term futures) is hedged by the VXZ (long term futures). It turns out that a the summer 2010 dip can be completely 'ironed out' by constructing a pair of short VXZ-long VXX, allocating 2x of the capital to VXX.  The graph below shows a portfolio of -22 shares VXX,  46 shares VXZ. Sharpe is just above 2.
Of course past returns are not necessarily representative for the future, but I imagine that during the next crisis this behavior could be repeated.
At this moment this strategy may be turning around, as downwards potential of the VIX seemes limited for now. But I can't wait for the next crisis. ;-).
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6 comments:

  1. AnonymousDecember 7, 2010 at 11:07 AM

    that is exactly what the UBS XVIX is

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  2. anonimoXXXDecember 7, 2010 at 11:10 AM

    this will work as far as there is contango. So will be useful always you don´t see VIX above 45, wich is quite strange only for secular crash.

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  3. Ernie ChanDecember 15, 2010 at 5:56 PM

    This is a very interesting observation. Would you now buy the VIX-2*VXZ spread instead of shorting it?

    I am confused by what inversorX meant by "this will work as far as there is contango". It seems to me the VIX futures are in backwardation (front contract more expensive than back contract) till 11/2009, but the spread keeps going lower until 10/2010.

    Ernie

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  4. sjevDecember 29, 2010 at 10:12 AM

    @Ernie: Sorry for the late reply, have been on vacation. Regarding going long with this pair: the latest data shows that it is indeed slowly turning around.

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  5. AnonymousJanuary 17, 2011 at 7:39 AM

    Whether to long or short the spread, or the ratio in that matter, depends entirely on the term structure, which changes all the time. No amount of backtesting tells you anything about how it would work next week. It's a discretionary trade, not a systematic one. It could be profitable, nonetheless.

    As for UBS's XVIX, it smells like a product created by quant strategists who are incentivized to create nice-looking strategies (for clients of course) by fitting the historical data and sold by traders/salespersons who make a living by charging you a management fee and generous spread.

    - A Quant Strategist Working at Investment Bank

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  6. sjevJanuary 17, 2011 at 7:54 AM

    @Anonymous: thanks for a bit of insider knowledge. This was basically the reason for me to start trading myself. This is the only way I can be sure that my interests come first.

    ReplyDelete

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