Utilizing Two Complementary Strategies to Trade VXX & XIV

In early December we made a second strategy for trading VXX and XIV available to our subscribers: the Volatility Risk Premium (VRP) strategy. You may remember me outlining the excellent performance of this strategy in my previous blog post, Volatility Strategies - Separating Fact From Fiction. I liked the strategy so much I decided to make a few adjustments and launch our own version of VRP to use along with our VXX Bias on our Daily Forecast page.

Why use two strategies for trading volatility ETPs? Because no single strategy is perfect and the market is inherently unpredictable. Using two complementary strategies simultaneously compensates for inherent weaknesses within each of the strategies, reduces drawdowns, and smooths out returns over months and years.

The VXX Bias and VRP strategies each take a very different approach for maximizing gains. The VXX Bias strategy is based on the term structure and momentum of VIX futures, while VRP is based on the price of VIX and historical volatility measurements. However, each of these strategies thrive and struggle depending on the specific market conditions. For example, the VXX Bias strategy has an advantage in handling periods of moderate drawdowns and sustained periods of backwardation. Meanwhile, the VRP strategy tends to be better with choppy markets and periods of gradually increasing volatility when VIX futures are in contango. 

You can see in the backtest results below that neither strategy consistently outperforms the other over a given year, although both VXX Bias and VRP are vastly superior to a buy-and-hold approach with XIV. 

As you can see in the chart above, using the VRP and VXX Bias strategies together (the green columns) provide more consistent returns than using just one strategy alone. In most years the "VRP + VXX Bias" strategy return falls roughly halfway between the VXX Bias and VRP strategies used on their own.  (Note: There are a couple ways to incorporate two strategies, but the easiest way is to trade in VXX or XIV only when they agree on the trade direction, which is how the above results are generated.)

Looking at the strategy statistics below, we see that the VRP + VXX Bias strategy benefits from a reduced maximum drawdown and a 0.90 Sharpe Ratio. 

Other relevant stats for trading only when VRP and VXX Bias agree on direction (years 2004-2014):

- # of trades: 191

- Avg hold time: 9.8 days

- # of days out of market in cash: 821 (out of 2711) --> 30%

- Avg trade return: 5.35%

- Max trade gain: 110.8%

- Max trade loss: -20.3%

The equity curve for each of the strategies (below) illustrates the smaller drawdowns and improved performance of using VRP and VXX Bias together:

Table of annual returns for the above data:

Full test data for both the VRP and VXX Bias strategies can be found in the spreadsheets at the bottom of the Subscribe page. You can also read more about our trading strategy on our Strategy page.

Access to our daily indicators and automated alerts for both the VRP and VXX Bias strategies is available via subscription to Trading Volatility+. 


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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 approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.

2015 CBOE Risk Management Conference - Attendees get 30% off Subscription to Trading Volatility+

CBOE's Risk Management Conference is the premier educational forum for users of volatility products and equity derivatives. It is *the* conference for financial professionals to attend to learn the latest risk management tools and tactics from top traders and strategists. 

The next CBOE Risk Management Conference is scheduled for March 4-6 in Carlsbad, California. The agenda is now set with talks from over two dozen industry experts, exploring the latest products, trading strategies and tactics used to manage risk exposure and enhance yields. The full agenda is available here.

As an added bonus, attendees at the March 4-6, 2015 session are able to get a 30% discount* on their first three months of a Trading Volatility+ subscription. 

Our Trading Volatility+ service provides access to:

• Our full suite of volatility metrics and indicators to bring you valuable insight into the movement of VIX ETPs, 
• Our strategies, which utilize variations on widely-used trading indicators (such as Volatility Risk Premium) as well as our own proprietary algorithms (VXX Bias^TM and ZIV Bias^TM),
• Our automated alerts which notify subscribers whenever one of our indicators experiences a critical change in direction, making the strategies easy to follow,
• Our members' forum where you can interact and share ideas with other volatility traders. 

The unique characteristics and profit potential of VIX futures led to the fifth consecutive annual trading volume record in 2014. 2015 is already looking to break that record again as interest in volatility as a tradable asset continues to grow. If you're still shying away from this well-kept secret of sophisticated investors, now is is the time to learn more. A good place to start is with our concise (and FREE!) e-book, Fundamental Concepts and Strategies for Trading Volatility ETPs.

*Discount available only to new subscribers. The discount will be refunded to subscribers after providing proof of event attendance.

Volatility Strategies - Separating Fact From Fiction

Earlier this year I came across the website Volatility Made Simple. Much like our goal at Trading Volatility, Volatility Made Simple's goal is to help less informed investors understand and take advantage volatility ETPs in a manner that is similar to how large institutions trade volatility.

What is really great about Volatility Made Simple, is that at the end of each month the performance of various volatility trading strategies is recorded. As of the November update there were twenty different strategies on the list, and according to him, they represent the vast majority of volatility trading strategies of traders timing these products.

Below is his image which illustrates the November performance of strategies compared to XIV buy-and-hold.

The other nice thing is that he will occasionally write posts which independently examine each strategy in depth, identifying the exact trading rules and performing backtests to 2004 to see how they perform under a variety of conditions. This is useful to make sure that a strategy is not just optimized for ideal markets but can also perform well in more turbulent environments. In addition he also provides statistics such as percent winning/losing trades, average trade return, and sometimes the max drawdown percentage and Sharpe ratios. Below I will post several of the charts from his site.

It gets interesting looking at the ten year returns of these strategies. Looking at VIX & More's (by Bill Luby) VIX:VXV ratio strategy, we can see that a portfolio of $10,000 in 2004 grows to a portfolio of over $1,200,000 by February 2014 when following these rules. Chart below:

From $10,000 to $1,200,000 -- that's a a 12,000% return in 10 years! That's remarkably impressive.

A similar strategy offered by Market Sci, the Mean Reversion Strategy, takes our portfolio of $10,000 in 2004 grows to a portfolio of over $1,200,000 as well, although it takes a slightly different path to get there. Chart for Market Sci's below:

Then there is Trading the Odds's Volatility Risk Premium strategy which boasts growth of $10,000 to over $5,000,000 (50,000% gain) over the same time frame, beating Market Sci's returns by a factor of five:

And if that return isn't enough, there's the Optimized VRP Strategy, which fine-tunes backtested performance to turn a portfolio of $10,000 to over $10,000,000 in 10 years. This strategy is achieved with an average of just eight trades per year. Chart below:

Wow. So should we be issuing a scam alert? A 100,000% return over 10 years?!? GET REAL!! Too good to be true, right?

Except that these strategies are all valid. The average investor who just buys index ETFs or scours the stock market looking for the hottest stocks in a struggle to outperform the S&P 500 (or just break even) will completely dismiss these returns as impossible. But for me, VIX and More, Market Sci, Trading The Odds, Volatility Made Simple, and all the other people who have developed one of these volatility strategies, these returns are real (Note: None of these people are aware that I'm writing this, they have no connection with the Trading Volatility site, and do not necessarily agree with or endorse anything I'm writing). 

How do I know that these ridiculous returns are likely to be legit without independently verifying them for myself? Because our VXX Bias strategy is right in the ballpark with the leaders (performance summary for our VXX Bias strategy can be found here).

When you look at the return over the entire period it seems astronomical. But actually this just demonstrates the power of compound interest. A portfolio of $10,000 that grows at 90% per year over 10 years is worth $6,131,066.26, which is roughly what the best strategies return. The trick is being able to average 90% per year while avoiding major drawdowns.

When I tell people about my strategy and the returns that can be achieved, everyone skeptically asks, "Why aren't other people doing this?" The answer is "THEY ARE!" 

Volatility Made Simple tracks a handful of strategies that have been made public. From what I can tell, and as VMS points out, most of the strategies apply similar concepts. Each strategy has its own strengths and weaknesses and many struggle through the same conditions. Because of certain optimizations, some strategies manage to excel over shorter time frames under certain conditions. However, over the years it's easier to see the order of magnitude of difference among the different strategies. I'd argue that a blend of two or three of the top strategies would be the best way to reduce variation in returns, however this may not be cost-effective for smaller accounts.

There are many other confidential volatility strategies out there. They belong to the smart money managers and institutions who are making money hand over fist. And the best part is that it doesn't matter if it is a bull or bear market. 2008 financial crisis? Not a problem -- in fact, a good strategy flips to buy volatility to take advantage of a steep market decline.

The fact is, volatility ETPs are generally giant scams designed to separate unknowing investors from their money. VXX and UVXY are obviously horrible over the long term but can go up 10x in a matter of months. Inverse volatility (XIV) looks good most of the time but is prone to 80%+ drawdowns that can wipe you out. People who understand how these products work can exploit their flaws to generate giant returns. 

For people trading volatility ETPs at a loss or barely getting by, you have a problem. Given the amount of free and paid resources out there, there's no excuse for this. Here are some things you may want to consider:

1) Find a signal-based trading plan that matches your style and fits in with your financial objectives. Make sure the strategy has signals that make it easy for you to follow.

2) Strictly trade based on hard rules. This will allow you to avoid making emotional decisions and fighting the trend, and will maximize long-term results.

3) Understand that day-to-day, week-to week, and month-to-month performance can result short-term negative returns. Don't lose focus of the long term.

4) You will have losing trades. This is why we focus on process and probabilities, not short-term outcomes. What matters is the process and patience.

5) If you are not able to follow rules, don't trade. Sorry to say, but if you can't find the discipline you don't get the profits (and you probably shouldn't be trading at all).


(It also helps to understand how VIX ETPs work. For an overview you can read my free eBook, Fundamental Concepts and Strategies for Trading Volatility ETPs.)

Most of the strategies on VMS's summary are similar in that they assess market conditions at the end of each trading day to determine if a buy or sell is necessary. They are also similar in the number of trades per year, typically between 7 and 30, making these strategies fairly manageable swing trades which do not require the investor to be glued to a trading screen all day.

When it comes down to it, I don't really care which strategy you choose as long as you are successful. It's just time to stop being one of the many unfortunate who are on the wrong side of the trade.

If you'd like more information on the Trading Volatility Bias strategy please visit this link. Our Bias indicators are automatically emailed at the end of each trading day and our Bias change alerts notify subscribers whenever the Bias changes direction, making it easy to follow. Our subscriber services are available for less than $3 per day making it very affordable.

You can also take advantage of our free VIX Futures Data pages as well as our SPY Arbitrage and Pivot Point tools. And if you have any questions at all, feel free to reach out to me via the Contact 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 approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.

2015 VIX Futures Expiration Days And Roll Period Lengths

As we get ready to head into 2015, I wanted to share the expiration date for each VIX futures month next year as well as the number of days in each roll period. Table below (source calendar).

Expiration Date           Roll Period Length

- Ending January 21:          22 days

- Ending February 18:        19 days

- Ending March 18:           20 days

- Ending April 15:              19 days

- Ending May 20:              25 days

- Ending June 17:              19 days

- Ending July 22:               24 days

- Ending August 19:           20 days

- Ending September 16:     19 days

- Ending October 21:         25 days

- Ending November 18:      20 days

- Ending December 16:      19 days

VXX & ZIV Bias Indicators - October 2014 Performance Update

Th U.S. Stock market experienced a wild October, with the S&P 500 falling 9.8% from its peak on September 19 to a low on October 15, followed by a two week rally back to all-time highs. This extreme move was matched with a +170% gain in VIX as it rose to a three-year high of 31.06. Highlighting the swiftness of this move, VIX gained more than 10% on three consecutive days for the second time ever. Then, just as swiftly, it retreated with an unprecedented decline of -10% on three consecutive days.

Our Daily Bias indicators read these moves well and produced two great trades. A change to a positive VXX Bias signaled a buy in VXX on September 18 and a change to a negative VXX Bias on October 21 signaled a VXX sell for a gain of 21%. The move to a negative VXX Bias on 10/21 signaled time to move back to short volatility by buying XIV, a trade that is +7% as of October 31. Both of these trades helped us continue our quest to once again outperform the market this year.

Looking at year-to-date performance of the two VXX Bias strategies through October 31:
- Negative VXX Bias strategy: +21% vs +2% for XIV
- Positive VXX Bias strategy:  -5% vs -28% for VXX

Extending the performance time frame of the Negative VXX Bias strategy back to 2012:
- Negative VXX Bias strategy: +566% vs +411% for XIV

Turning attention to ZIV, the Positive ZIV Bias strategy was +1.3% in October bringing the YTD total to +4.8%.

Over the longer time frame back through 2011:
 - Positive ZIV Bias strategy: +391% vs 256% for ZIV.

Performance Data files: 
- VXX Bias: 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014
                - 2012-2014 (multi-year)

- ZIV Bias: 2011-2014 (multi-year)


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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.