Trading XIV & VXX Based on Data & Probabilities

You can't win in trading if your decisions are based on emotions, instincts, or hunches. Consistently successful trading requires objective and data-driven signals to identify trades with the highest probability of success. 

Fortunately, the market is always providing data-based clues on its trend as well as market sentiment. At Trading Volatility, our favorite indicators for trading both XIV/VXX and the broader market are the Bias and Spike Risk indicators. By taking a look the six month chart of these indicators (always posted on our Daily Forecast page) we can clearly see how sentiment has shifted over this time and the probabilities of a falling XIV/rising VXX have materially increased.

Our VXX Spike Risk forecasts the probability of a rise of 7% or more in VXX over the next two days. In the graph below you can see each day's forecasted Spike Risk (available at 4:30pm ET on the previous day) aligned with the percentage gain/loss of VXX.  There are three primary periods over the past six months:

1) Low risk (Apr 23 - June 10) - Spike Risk forecasts range between 15% and 35% while percent daily changes in VXX are mostly negative.

2) Mixed Risk (June 12 - Aug 19) - Spike Risk forecasts range between 16% and 58% in a choppy and indecisive market. Daily percent changes in VXX are mixed with big moves in both directions and a cluster of VXX gains in late July/early August while Spike Risk was elevated between 40% and 57%.

3) Moderate Risk (Sept 9 - today) - Spike Risk forecasts range mostly between 35% to 56%. VXX is seeing more up days than down days in its current trend, culminating with the most recent data point of a 56% Spike Risk with VXX +9% today. 

The readings from the Spike Risk forecast are reflected in our primary indicator for tracking trends in VXX and XIV, the VXX Bias. This is the key signal for us to trade with the trend and remain objective. Ultimately, the VXX Bias (left axis below) provides an indication of the directional pull of VXX. There are 3 distinct sections we can see in this chart as well. 

1) A negative VXX Bias during the low risk period (Apr 28 - June 16).

2) A mixed bias during out mixed risk period (June 17 - July 23).

3) A positive VXX Bias during the moderate risk period (Sept 19 - present)

You'll probably note some shorter periods of VXX Bias as well. Here we can highlight the fact that a positive or negative Bias forecast does not guarantee that VXX price will follow, however it certainly puts the odds in our favor. The signals keep us objective and help remove emotion from trading in a difficult market to set us up for long-term success. 

For full performance details of our Bias indicators visit this post. To go more in-depth on VIX, VIX futures, and our Bias indicators, check out our new e-book, available for free on Scribd.

Watching For The Return Of Volatility

Hello and welcome back! I hope everyone had a great Thanksgiving break.

Today I wanted to provide a brief look back on volatility over the past several weeks and provide my thoughts on what it means going forward. Ever since the debt ceiling deadlock concluded in October, VIX has remained in a fairly tight range between 12 and 14. Meanwhile, the S&P 500 has notched eight straight weeks of gains.

In this post I'll be covering:

• Technical Review
• Forecast Review
• Nov 15 VIX Reversal
• Elevated SKEW
• Trading Plan (Member Access Only)

Technical Review
Taking a look at the chart of implied volatility vs actual volatility (from the VIX Futures Data page), we can see that the current VIX range is roughly the same as what we saw in the July/August timeframe (orange highlight), which at the time, bounced along the floor set by HV60 (actual volatility over the last 60 trading days). Actual volatility in the S&P 500 has continued to decline since then and the HV60 floor is now two points lower, hitting 10.28 on Friday. This premium in VIX to HV60 tells us that options sellers are not yet convinced that the low volatility environment we are currently experiencing will continue into 2014.

The VIX futures term structure shows us a pretty consistent contango since mid October, with nearer months cheaper than the more distant months. Overall the movement has been mostly sideways with a slight decline across all months, while the front months futures have fallen more rapidly toward spot VIX.

Forecast Review
Looking at our forecast charts we can see that the Bias (left axis) has remained mostly negative for VXX and positive for ZIV. During this past 6 months VXX has declined from $80 to $45 (-43%), while VXX inverses (XIV and SVXY) have each gained 45%. Meanwhile, ZIV has increased 18%, moving from $30 to $35.80.

Taking a look at the VXX Spike Risk forecast we can really get a feel for how sleepy the volatility market has been lately with only a couple days above the 30% risk mark over the past 6 weeks.

Nov 15 VIX Reversal
On Nov 20th I posted in our Members' Forum about a possible reversal in the VIX daily chart that occurred on Nov 15th. While it is still possible to break lower, this remains something for VIX traders to watch in the coming weeks, especially as we press up against the 200 day moving average at 14.37 (red dashed line).

Elevated SKEW
The CBOE SKEW index has been elevated near 130 for a few weeks now (weekly chart below) and is at its highest levels since March 2012. This value tells us that the options market views a higher probability of returns that are two or more standard deviations below the mean over the next 30 days, which represents a 15%+ decline in the S&P 500. Given the recent run-up in stocks an expectation of a pullback isn't too surprising, but is something to be prepared for nonetheless.

Trading Plan (Member Access Only)
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Update To VXX Spike Risk Forecast Algorithm

Today we made an update to our algorithm for the VXX Spike Risk forecast. The change is designed to refine the forecasts to provide increased accuracy.

The forecasts now estimate the probability of a spike in VXX of 7% or more (previously 8% or more) for the next 2 days (previously 3 days). The changes results in:

• An overall lower spike probability for most days (due to the shorter prediction period)
• An increased spike probability when spike conditions are present (due to a lower spike definition threshold)

See below for before and after graphs of the forecasted results over the past 6 months.

No changes were made to any of the Bias forecast calculations.



Before changes:

After changes [updated 9/18/13]:

Looking Ahead At VIX & VIX Futures Near All-Time Market Highs

The stock market has been rallying in full force over the past month with the S&P 500 up 7.2% since it put in its low on 6/24.

VIX has fallen 34.5% since that date with VIX futures following suit across the board (see chart below), driving VIX-related ETPs accordingly:

XIV:  +40.7%

ZIV:  +16.6%

VXX: -30.0%

UVXY: -52%

Our Daily Forecasts have performed well over this time, with the VXX bias shifting from positive back to negative on the evening of 6/21...

...and the VXX Spike risk dropping back below the danger zone (60%) on the evening of 6/25 and staying there ever since.

Actual historical volatility of the S&P 500 has started coming into play to hold the VIX up a bit. HV60, the actual volatility over the past 3 months (60 trading days), is serving as a floor to the VIX, as can be seen in the chart below.

For trading of VIX ETPs over the coming weeks what's important to note is...

Continue reading this post on the Members' Forum

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VIX Nears A Floor After A Week Of Heavy VIX Selling

VIX took a holiday as well this week falling 11.9% from last Friday's close. The VIX Futures term structure contango steepened as all months along the curve fell in proportion to VIX. Here's the week over week change in term structure:

From our daily forecasts we can see that after a month of elevated spike risk, the VXX Spike Risk forecast fell below the 5.0 "danger zone" on the evening of June 26th and remained there this week, with VXX losing 12% since that time (and XIV +13.3%).

Spot VIX is starting to press down towards the VIX "floor" set by actual market volatility over the past 3 months (HV60), with VIX now just 5% higher than HV60. We could still see VIX press down into the 13s, but I don't expect it to head much lower (see green circles below).

UPDATED 7/8: Corrected week-over-week term structure chart and VIX % change