2013 Performance Recap - Part 1

Now that 2013 has drawn to a close it's time for a performance recap of the Trading Volatility trading strategies. I'll be covering performance in two posts:

1) "WRY - 10SMA" Strategy
2) "Bias" Strategy for VXX & ZIV

1) "WRY - 10SMA" Strategy
Last month I introduced a strategy to enter and exit trades based on whether the Weekly Roll Yield (WRY) for VXX is above or below its 10-day moving average. It uses the chart from the VIX Futures Data page, shown below, to buy XIV (the inverse of VXX) when the WRY is less than its 10SMA (blue line is below the thin purple line), and buy VXX when the WRY is greater than its 10SMA (blue line is above the thin purple line).

1A) First, let's look at the performance of the "WRY < 10SMA" trade back to the inception of VXX in 2009 (data available here).

Cumulative Return Jan 30, 2009 - Dec 31, 2013

XIV: +1,691% 

"WRY < 10SMA": +1,870%

*Note: Results assume that gains are reinvested; prior to inception of XIV the inverse daily return of VXX is used to calculate the daily closing price of XIV. 

Focusing now on performance in 2013, you can see from the chart below that the "WRY < 10SMA" strategy under-performed a bit in a choppy market. One of the benefits of this strategy is that it helps to reduce drawdowns experienced by XIV and protect the portfolio in case the market sees a larger selloff, but it can come at the cost of missing out on "rebound gains" in an event-driven market. Hypothetical performance data available here.

  

Cumulative Return Jan 1, 2013 - Dec 31, 2013

XIV: +107% 

"WRY < 10SMA": +86%

"WRY < 10SMA" Trade Summary, 2013

• # of Gains: 11
• # of Losses: 10
• Avg Return: +3.4%
• Max Gain: +27.3%
• Max Loss: -6.5%

Trade histogram of gains & losses for "WRY < 10SMA" in 2013:

1B) Next is the other half of the strategy, "WRY > 10SMA", in which VXX would be bought. As noted in my introductory post on this strategy, the gains obtained using this strategy in the early part of the trade are almost always gone by the time the WRY crosses back below the 10SMA. Because of this it makes sense to close trades early or skip this half of the trade altogether (hypothetical performance data available here).

"WRY > 10SMA" Trade Summary, 2013

• # of Gains: 6
• # of Losses: 13
• Avg Return: -2.2%
• Max Gain: +7.9%
• Max Loss: -11.5%

Trade histogram of gains & losses for "WRY > 10SMA" in 2013:

In my next post I'll cover the performance of the "Bias" strategies (from our Daily Forecasts) for both VXX and ZIV .


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Hypothetical and Simulated Performance Disclaimer
The results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Additional performance differences in backtests arise from the methodology of using the 4:00pm ET closing values for XIV, VXX, and ZIV as an approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.

Volatility Trading Made Simple And Profitable

[Updated on 12/11/13 at 4:48pm PT]

Last week we added a new chart to the VIX Futures Data page which plots the daily closing value of the VXX Weekly Roll Yield, WRY, against its 10-day simple moving average.

This new chart provides traders with simple entry and exit signals that can be used to measure the momentum of VXX, UVXY, XIV, and SVXY.

There are two "halves" of this trading strategy:
1) being short VXX/UVXY (or long XIV/SVXY) whenever the WRY is below its moving average, and
2) being long VXX/UVXY (or short XIV) whenever the WRY is above its moving average.

Below is the current chart.

I've backtested the strategies separately for "short VXX only" and "long VXX only" from the inception of VXX (1/30/2009) through 12/10/2013. Decision points are made using the day's closing data (individual trades in the analysis can be viewed here).

For short VXX only:

• # of Gains: 59
• # of Losses: 47
• Avg Return: +4.1%
• Max Gain: +40.4%
• Max Loss: -19.2%
• Sum of Gains & Losses: +438.6%

For long VXX only:

• # of Gains: 32
• # of Losses: 74
• Avg Return: -0.8%
• Max Gain: +60.6%
• Max Loss: -17.4%
• Sum of Gains & Losses: -81.9%

---> Sum of all gains and losses: +356.7%

Below are the histograms for each of the strategies, grouping the number of trades that occurred in various blocks of percentage points.

The biggest block of returns for trades using the short VXX strategy is between -4% and 0%, which had 27 occurrences.

The biggest block of returns using the long VXX strategy is also between -4% and 0, which had 37 occurrences. Most of these trades experience gains in the first couple days but end up in a loss as VIX futures revert back to their mean.  

The Weekly Roll Yield chart is available to all Trading Volatility members. For more information on subscriptions see our subscribe page.

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Hypothetical and Simulated Performance Disclaimer
The results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Additional performance differences in backtests arise from the methodology of using the 4:00pm ET closing values for XIV, VXX, and ZIV as an approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.

The #1 Rule For Trading Volatility ETFs

Every couple weeks or so I see a new article from someone giving advice on how to trade volatility ETFs & ETNs such as XIV, VXX, SVXU, UVXY, and ZIV. Often the author will at least know that these products trade based on the VIX futures. But every once in awhile I'll see something more misguided, like the chart below. While it looks promising, once it is applied to historical data it does not deliver positive results.

For example, let's take a look at the period between August 2004 and May 2006 when VIX bounced between 10 and 16 (VIX on left axis; VXX on right axis). The chart says buy VXX below a VIX of 16.

The return for VXX during this time was -75%, a loss attributed to the fact that the front two months were in contango with a spread averaging 0.98.

Let's continue on to the next period, between May 2006 and Feb 2007 when VIX was spending much of its time between 10 and 12.  The result for VXX is a 57% loss, and again the reason is a contango term structure, with an average spread between front month futures (M1) and 2nd month futures (M2) of 0.85.

You may point out the spike in VXX from $1000 to $1350 on the left hand of the chart, which is a nice 35% gain. Unfortunately, if you were following the chart and buying XIV when VIX rose above 16 then you would have lost 30% over the next couple of weeks before almost breaking even if you held your position until VIX dropped below 16 again.

OK, so I can hear some of you saying that I'm cutting off the chart before VIX and VXX spikes. Take a look at the next period, from Feb 2007 to Feb 2011 when VIX spiked during the 2008 crash. During this time VIX was above 16. Since the chart above says buy XIV when VIX is above 16, I'll compare VIX (left axis) to the price of XIV (right axis).

The result is a 64% loss up until Dec 2007, followed by another 66% loss from Aug 2008 to Dec 2008, for a total of an 88% loss in XIV from 2/27/07 to 12/19/08.  At this point your position has essentially been demolished after this 21 month period. But let's give you the benefit of the doubt and say that you stayed solvent and held on to this position for the 4 year period until VIX dropped below 16 again. In that case you managed to almost break even in that XIV trade.

Looking at the term structure during this period, we find that between 2/27/07 and the bottom in 12/19/08 the term structure was in backwardation, with an average of a 0.67 spread between the first two months. Backwardation has the effect of making VXX rise and XIV fall.

From 12/20/08 to 3/24/2011, when the price in XIV goes up from 2 to 14 for an excellent 7x return, the term structure is back in contango with an average of 1.51 points between M1 and M2. Contango has the effect of making XIV rise and VXX fall.

At this point, the #1 rule in trading volatility-based ETFs should be clear: Follow The Term Structure.

The term structure is going to be the biggest driver of price for volatility-based ETPs over time. There are of course other factors that need to be taken into account when trading volatility ETPs in order to maximize your gains, but you will be able to trade these products pretty well just by following this rule.

To view the current term structure and other metrics that are critical to trading volatility ETPs, visit the VIX Futures Data page.


**Note: VXX and XIV price data prior to the funds' first trading days (1/30/2009 for VXX and 11/30/2011 for XIV) have been calculated by using the VIX short-term futures underlying index values derived from actual data of month 1 and month 2 futures.

New SPY Arbitrage Tool Available

I'm happy to announce the availability of a new trading tool on the Trading Volatility site, the SPY Arbitrage Model. 

The model is updated in real-time throughout the day, plotting the S&P 500 (SPY) against a model of the implied value for the S&P 500 as derived from a collection of related assets (volatility (XIV), interest rates (TBF), and credit (HYG)). With this model a trader can place relatively low risk arbitrage trades to take advantage of prices as they diverge and recouple during the day.


Let's take a look at Friday's data: 

To get the most our of this trade you want to look for points at which the difference between SPY and model are large -- generally +/-$0.20 is a good rule of thumb depending on your trade sizes and transaction costs.  On the areas I highlighted above, the second area I highlighted (towards the end of the day) provides a better opportunity than the first, as the difference between SPY and model is $0.30. The trade approach is then to sell the SPY while simultaneously buying the components in the model. Once the SPY and model converge, positions should then be closed.

To maintain near market-neutral on the trade the weighting of each component needs to be balanced according to the beta for each component, at least as a starting point (this is a topic I'll cover in another post). Some adjustments can be made based on where each component is trading. Again, consider data from Friday:

When the arbitrage opportunity opened up in the last hour of trading, two components of the model were lagging (XIV and HYG) the SPY, while TBF was essentially in line.  In this case an alternate trade would have been a short position in the SPY, but only take longs in XIV and HYG since it is less likely that TBF would make an upward move while SPY moves lower. This helps to maximize gains and reduce transaction costs.

Important note: If your positions are small relative to your transaction costs or if you are subject to wash sales rules, this may not be a good strategy to employ. I recommend crunching the numbers for your specific situation to determine if this strategy is right for you.