TRADING THE ODDS http://www.tradingtheodds.com A quantitative approach to profit in the US and European equity and futures markets, trading the markets like professional card counters are playing Blackjack or expert poker players are playing Poker. The key is to have the odds on your side and bet accordingly, knowing what, when, where, why and how much to bet on each trade or wager. Sun, 02 Aug 2015 19:21:42 +0000 en-US hourly 1 The VIX® – A Rear-View Mirror Or Crystal Ball http://www.tradingtheodds.com/2015/02/the-vix-a-rear-view-mirror-or-crystal-ball/ http://www.tradingtheodds.com/2015/02/the-vix-a-rear-view-mirror-or-crystal-ball/#comments Wed, 11 Feb 2015 16:12:35 +0000 http://www.tradingtheodds.com/?p=42128 My insights have always been – and will probably be – offered for free, but if the information provided is helpful for your own trading business, any donation to my Be it! Children’s Charitable Foundation is much appreciated (donations can be sent via PayPal, see button on the right).   Most recently there has been […]]]>

My insights have always been – and will probably be – offered for free, but if the information provided is helpful for your own trading business, any donation to my Be it! Children’s Charitable Foundation is much appreciated (donations can be sent via PayPal, see button on the right).


 

Most recently there has been a lot of chatter and discussion in the financial blogosphere regarding the CBOE Volatility Index (VIX®) soaring higher since December 5, 2014 when the index closed at its preliminary low of 11.82 (the index closed at 22.39 on January 15, 2015), despite the fact that the S&P 500 Index has (almost) always trading in short distance to its all-time high of 2,090.57.

But if you don’t think of (historical / realized) volatility in terms of daily closing prices only, but take into account intraday and day to day high / low prices as well, the solution might present itself.

Table 1 below shows the 1 month, 3 months and 1 year average, 1 standard deviation(s), maximum and minimum values of the 5-day exponantial moving average of the maximum of daily (intraday) ups and downs – blue line -, calculated as follows:

5-day EMA [ LN [ MAX (

  • today’s intraday high / today’s intraday low ;
  • 1 + ABS [today’s intraday high / yesterday’s intraday low – 1] ;
  • 1 + ABS [today’s intraday low / yesterday’s intraday high – 1] ;

)]]

(in order to get positive values and absolute movements only)

With 2.01%, the current 1 month average is running way above the 3 months and 1-year average, with a very low standard daviation of 0.24%, and has never been lower than 1.56% over the course of the last month.

Term   5-day EMA …
1 month AVG 2.01%
  SD 0.24%
  MAX 2.54%
  MIN 1.56%
 3 month AVG 1.52%
  SD 0.63%
  MAX 2.88%
  MIN 0.59%
 1 year AVG 1.34%
  SD 0.55%
  MAX 3.13%
  MIN 0.59%

 

Image I below shows the 1-year relationship between the CBOE Volatility Index (VIX®) (red line) and the 5-day exponantial moving average of the maximum of daily (intraday) ups and downs (blue line).

 

Image I – VIX® vs. 5-day EMA [2-day Max. Intraday Volatility]
(02/10/2014 – present)

The high correlation between both curves is more than striking. The VIX® index mirrors the 5-day EMA of … very closely, independently if those bigger intraday swings happend on a monthly/annual/all-time S&P 500 index high.

 

Image II below shows the historical distribution (01/02/1990 – present) of VIX® values when the 5-day EMA of … closed between 1.75% and 2.25%, as it did most of the time over the course of the last month. On average the VIX®  was trading at or around 20.82 , close to the average VIX® value over the course of the last month.

Image II – VIX® vs. 5-day EMA [2-day Max. Intraday Volatility]
(01/02/1990 – present)

 

In contrast: Image III below shows the historical distribution (01/02/1990 – present) of VIX® values when the 5-day EMA of … closed between 0% and 1.00%. With such low intraday swings, it should come to nobody’s surprise that the VIX® was trading between 12 and 14 almost 90% of the time.

Image III – VIX® vs. 5-day EMA [2-day Max. Intraday Volatility]
(01/02/1990 – present)

 

From my perspective the VIX® seems to be highly correlated to then then recent (realized) intraday volatility (looking into the rear-view), with market participants regularly expecting a continuation of this high/low intraday volatility. You will rarely see a low realized volatility (5-day EMA of … lower than 1.00%) in combination with a much higher VIX® value (acting a fear gauge representing market participant’s expectation of S&P 500 index volatility over the course of the then following 30 days), and vice versa.

__________________

Have a profitable week,

Frank


Disclosure: I’am long/short XIV, and long/short VIX, RVX and EURO STOXX 50 volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments. The results are regularly based on simulated data and/or hypothetical performance and do not represent real trading.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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Volatility Risk Premium Strategy – And The (Preliminary) Outperformer Is … http://www.tradingtheodds.com/2015/01/volatility-risk-premium-strategy-and-the-preliminary-outperformer-is/ http://www.tradingtheodds.com/2015/01/volatility-risk-premium-strategy-and-the-preliminary-outperformer-is/#comments Tue, 27 Jan 2015 10:14:16 +0000 http://www.tradingtheodds.com/?p=42054 My insights have always been – and will probably be – offered for free, but if the information provided is helpful for your own trading business, any donation to my Be it! Children’s Charitable Foundation is much appreciated (donations can be sent via PayPal, see button on the right).   A couple of weeks ago […]]]>

My insights have always been – and will probably be – offered for free, but if the information provided is helpful for your own trading business, any donation to my Be it! Children’s Charitable Foundation is much appreciated (donations can be sent via PayPal, see button on the right).


 

A couple of weeks ago I started a series of postings, all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due to its exceptional performance – at least until December 2012 (original version) – and its compelling approach (from the paper Easy Volatility Investing from Double-Digit Numerics).

Since then a couple of bloggers have taken up this issue (VRP) as well ( e.g. Volatilty Made Simple , Trading Volatility , QuantStrat TradeR , Evolution Trading , among others), some offering their services (including a VRP strategy) and insights for free while others are subscription based. If you’re interested in the topic, please check for their blogs (highly recommended).

Most recently Volatilty Made Simple had an interesting article ( here ) about the different measures of implied volatility (e.g. VIX®, VXMT®, VX 30-day constant maturity) I present over the course of the series of postings mentioned above, and he is completely correct when concluding ‘that any advantage of one over the others is likely the result of random chance‘. Fortunately I’ll show you that there is a huge but: ‘average’ does not mean ‘average’ , especially in combination with those different measures of implied volatility mentioned before.

But first of all the Volatility Risk Premium (VRP) Strategy rules (always market on close):

  • Long XIV: 5-day average of [VIX® – (2-day historical volatility of S&P 500 * 100)] > 0
  • Long VXX: 5-day average of [VIX® – (2-day historical volatility of S&P 500 * 100)] ≤ 0
  • Hold until a change in position.

Image I shows the respective equity curves when – this time – utilizing different kind of averages instead of different measures of implied volatility (with one exception to the rule):

black line : Inverse Distance Weighted Moving Average (IDWMA)

grey line : Distance Weighted Moving Average (DWMA)

blue line : Simple Moving Average (SMA)

orange line : Exponential Moving Average (EMA)

green line : Exponential Moving Average, utilizing VIX® futures VX1|VX2 , merged into a continual time series as a 30-day constant-maturity futures price ( the underlying for VXX® and XIV® ), and using 1 instead of 0 as cutoff.

Utilizing the VX1|VX2 cont. contract in combination with an (5-day) exponential moving average and 1 as cutoff outperforms all other averages by a wide margin and way beyond any S&P 500 / XIV® buy-and-hold strategy (but please note: these are all hypothetical – not actual trading – results, based on partly simulated VXX® and XIV® data), despite the fact that it – up to now – doesn’t use any kind of position sizing and/or money management (the strategy is always all-in), no intraday buy/sell stops (end-of-day prices and orders only), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), the strategy is not adaptive (do not adjust to the ongoing changes in market conditions like bull and bear markets), there is no over-optimization (e.g. by applying additional rules for seasonalities like FED announcement days, the last 2 days before maturity, S&P 500 overbought/oversold conditions, among others), and none of those findings presented before on this blog are applied, and and and.

 

Image I – Total Equity Curve(s)
(03/26/2004 – present)

Image II – Drawdown Curve(s)
(03/26/2004 – present)

 

Image III shows the respective statistics (key figures) side by side.

 (click on image to enlage)

Image III – Statistics – Sidy by Side Comparison
(03/26/2004 – present)

 

And last but not least monthly and annual returns (despite the German term for the respective months, I think you get the picture).

 (click on image to enlage)

Image IV – Performance Summary – Monthly and Annual Returns
(03/26/2004 – present)

 

This will for sure not be my last posting dealing with the Volatility Risk Premium Strategy. From my perspective still the biggest hurdle to overcome are those periods in time when implied volatility (investor fear) is on the rise while realized volatility remains relatively calm, forcing the strategy to stay long XIV® (short volatily) way too long and driving the net asset value into a severe drawdown, like it happened most recently (since December 2014).

to be continued … (means more on this to come, stay tuned)

__________________

Have a profitable week,

Frank


Disclosure: I’am long/short XIV, and long/short VIX, RVX and EURO STOXX 50 volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments. The results are regularly based on simulated data and/or hypothetical performance and do not represent real trading.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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Timing (And Trading) Implied Volatility http://www.tradingtheodds.com/2015/01/timing-and-trading-implied-volatility/ http://www.tradingtheodds.com/2015/01/timing-and-trading-implied-volatility/#comments Sun, 18 Jan 2015 20:42:49 +0000 http://www.tradingtheodds.com/?p=42013 The majority of readers will already be familiar with the fact that the CBOE Volatility Index® (VIX®) is not a tradable asset (it is just a number), and trading the VIX® in fact means trading its derivatives (futures) or even derivatives of derivatives (options on futures, ETFs/ETNs like XIV® – VelocityShares Daily Inverse VIX Short-Term ETN […]]]>

The majority of readers will already be familiar with the fact that the CBOE Volatility Index® (VIX®) is not a tradable asset (it is just a number), and trading the VIX® in fact means trading its derivatives (futures) or even derivatives of derivatives (options on futures, ETFs/ETNs like XIV® – VelocityShares Daily Inverse VIX Short-Term ETN – and VXX – iPath® S&P 500 VIX Short-Term Futures™ ETN – ).

Due the mean reverting nature of the VIX® (e.g. when bottoming out in the 10-12 range, a sudden spike is much more likely than a further drop, and conversly after a sudden spike to extended levels, a (quick) drop and/or slow decrease to regular levels is just a question of time and much more likely than a further rise), timing and trading the VIX® would of course be much easier than timing and trading its derivatives (and derivatives of derivatives) where one has to take into account (and overcome) time to maturity (futures, options), time decay, risk premium (futures, options, ETFs/ETNs), roll yield (ETFs/ETNs), term structure (contango/backwardation of futures), seasonalities (e.g. FED announcement days, the last days before maturity, …), among others.

Some time ago MarketSci published an intersting article about timing (and trading) the VIX®Random Thoughts RE: Trading Volatility ETFs (Part 1) ), utilizing a 10-day EMA (Exponential Moving Average) and a 10-day SMA (Simple Moving Average), going long (selling short) the VIX® index at the close when the 10-day EMA of the VIX® closed under (over) the 10-day SMA. Expectably (selling short an asset which is always bottoming out in the 10 – 12 range) – in contrast to going long the XIV® (selling short volatility) – the short side of the trade was more or less treading water over the course of the time frame under review (since 1990) while the long side went straight up (low risk / high reward).

But as previously shown, with respect to a highly volatile asset like the VIX® , a 10-day moving average – even an EMA – is disadvantageous compared to a shorter-term moving average. And additionally – at least with respect to trading the Volatility Risk Premium Strategy – utilizing the CBOE Mid-Term Volatility Index ( VXMT® ) as a the repective trigger index instead of the VIX® may have some benefits again as well.

To make a long story short:

Image I shows the respective equity curves:

(1)  VIX® with 10d EMA vs. 10d SMA: blue line (complies to MarketSci’s posting)
(2)  VIX® with   3d EMA vs. 10d SMA: grey line
(3)  VIX® before 1/1/2008 , VXMT® after 1/1/2008 with   3d EMA vs. 10d SMA: red line
(4)  120% of VIX® | –20% of VXMT® with   3d EMA vs. 10d SMA: black line
       * just VIX® before 1/1/2008 , VXMT® after 1/1/2008
(5)  120% of VIX® | -20% of (VIX® + 10%) with   3d EMA vs. 10d SMA: green line
       * before 1/1/2008, VIX® had been increased by 10% in order to replicate the VXMT®

 

Image I – Total Equity Curve(s)
(01/01/1990 – present)

 

Some remarks are mandatory:

(1) Any additions/changes in the respective underlying are only related to the exponential moving average ( e.g. 120% of VIX® | –20% of VXMT® ). The 10-day SMA remains unchanged and is always based on the VIX® index.

(2) The blue line represents MarketSci’s 10-day EMA | 10-day SMA mean reversion strategy. The respective performance (hypothetically trading the VIX®) could’ve been easily boosted by utilizing a 3-day EMA instead of a 10-day EMA ( grey line ). Simply replacing the VIX® by the VXMT® index ( red line ) would be very disadvantageous (a least with respect to a mean reverting strategy) due to the fact that the VXMT® is regularly trading (significantly) above the VIX® index  ( contango ). Even better works a mixture of 120% VIX® minus 20% of VXMT® , regularly (artificially) reducing the index value ( black line ).

(3) This very simple mean reversion strategy works best when applying this kind of ‘mixture’ right from the start, means first of all simulating VXMT® index values in the simplest way by adding a constant 10% premium to VIX® index values before VXMT® index values are available (1/1/2008), and secondly applying the previously mentioned formula again ( 120% of VIX® | –20% of  (VIX® + 10%).

Image II shows the respective equity curves (long / short seperately) for MarketSci’s 10-day EMA | 10-day SMA (black / grey) and the 120% of VIX® | -20% of (VIX® + 10%) with 3d EMA vs. 10d SMA (green line) mean reversion strategy.

 

Image II – Total Equity Curve(s)
(01/01/1990 – present)

 

And last but not least – probably surprising the most – the respective Summation Index, simply representing the running total of net advances = raw quality of forecast (getting an index move right: +1 ; getting it wrong: -1). This image clearly shows that trading is NOT about being right or wrong (means just getting the direction of the move right), but all about making money (effectiviness and efficiency). MarketSci’s 10-day EMA | 10-day SMA (blue line) and the 120% of VIX® | -20% of (VIX® + 10%) with 3d EMA vs. 10d SMA (green line) mean reversion strategy are at equal level (at the end of the field !), but the latter strategy is doing things in an optimal way, being right when the VIX® index  moves big and losing small when being wrong (it ouperforms the 10-day EMA | 10-day SMA strategy by a factor of 1E+8) while the “VIX® before 1/1/2008 , VXMT® after 1/1/2008 with 3d EMA vs. 10d SMA” ( red line ) is at the top of the pack even after 1/1/2008, unfortunately winning small and losing big, depleting its net asset value since 1/1/2008 by 99.9%.

 

Image III – Summation Index
(01/01/1990 – 10/15/2014)

 

But how to take advantage of these findings will be subject to another posting. And may be some food for thought for your own analysis as well.

to be continued … (means more on this to come, stay tuned)

__________________

Have a profitable week,

Frank


Disclosure: I’am long/short XIV and long/short EURO STOXX 50 volatility futures.

 

XIV® VelocityShares Daily Inverse VIX Short-Term ETN
VXX® iPath® S&P 500 VIX Short-Term Futures™ ETN
VXMT® CBOE Mid-Term Volatility Index
   

 

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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Trading (Mid-Term) Volatility – Periods Of Low Historical Volatility http://www.tradingtheodds.com/2014/12/trading-mid-term-volatility-periods-of-low-historical-volatility/ http://www.tradingtheodds.com/2014/12/trading-mid-term-volatility-periods-of-low-historical-volatility/#comments Fri, 19 Dec 2014 18:21:00 +0000 http://www.tradingtheodds.com/?p=41942 A couple of weeks ago I started a series of postings, all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due […]]]>

A couple of weeks ago I started a series of postings, all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due to its exceptional performance – at least until December 2012 – and its compelling approach (from the paper Easy Volatility Investing from Double-Digit Numerics).

This posting is about trading the ZIV® (VelocityShares Daily Inverse VIX Medium-Term ETN) – linked to the inverse of the daily performance of the S&P 500 VIX Mid Term Futures™ Index ER, and VZZ® (iPath Long Enhanced S&P 500 VIX Mid-Term Futures ETN) – linked to a leveraged return on the performance of the S&P 500 VIX Mid-Term Futures™ Index TR – , offering exposure to a daily rolling short|long position in the 4th, 5th, 6th and 7th month VIX® futures contracts.

At the same time, I’d like to address a problem which specifically applies to the Volatility Risk Premium Strategy (but probably not limited to): Periods of relatively low historical volatility, while implied volatility ( VIX® and the respective front and second month futures (Ticker: VX1|VX2) ) either spikes up or at least (steadily) rises to a (significantly) higher level (investor fear). Due to the fact that during those periods implied volatility continuously (significantly) exceeds historical (realized) volatility, the strategy keeps holding onto a losing position ( XIV® or ZIV® ) instead of buying into the momentum ( VXX® or VZZ® ).

But first of all the customized Volatility Risk Premium (VRP) Strategy rules (always market on close):

  • Long ZIV: x-day moving average of [VX1|VX2 (30-day const. maturity) – 2-day historical volatility of S&P 500 * 100] ≥ 1
  • Long VXZ: x-day moving average of [VX1|VX2 (30-day const. maturity) – 2-day historical volatility of S&P 500 * 100] < 1
  • Hold until a change in position.

Please note: Ticker: VX1|VX2 represent the VIX® front and second month futures, merged into a continual time series as a 30-day constant-maturity futures price (the basis for VXX® and XIV®).

Image I shows the respective equity curves: the VRP (customized) Strategy (black line), and – for exemplary purposes (with hindsight!) – in order to demonstrate the problem mentioned above and a possible solution at the same time – a tuned copy of the VRP (customized) Strategy (blue line), where during periods of relatively low historical but rising (rocketing) implied volatility (highlighted by yellow boxes) historical volatility has been leveraged by a factor of 10 (finally in order to trigger a buy VXZ® more often).

The respective periods are (in excerpts, for exemplary purposes):

# from to
1 4/3/2006 6/30/2006
2 4/2/2007 12/31/2007
3 4/15/2010 5/19/2010
4 2/15/2011 3/16/2011
5 8/15/2011 10/3/2011
6 5/10/2013 6/20/2013
7 7/23/2014 9/30/2014
8 12/5/2014 12/15/2014

 

Image I – Total Equity Curve(s)
(03/25/2004 – present)

It is clearly recognisable that while the basis strategy (not leveraged) shows a poor performance during those periods of low historical / rocketing implied volatility (due to holding onto a losing position in ZIV® way too long until finally historical volatility keeps pace up with implied volatility, especially during time frame 2), the tuned (leveraged) strategy switches from short to long volatility at the proper time.

Image II shows time, duration and severity of respective drawdowns (including the tuned (leveraged) strategy’s advantage/disadvantage compared to the basis strategy (yellow areas).

Image II – Drawdown Curve(s)
(03/25/2004 – present)

Image III shows the respective statistics. Please keep in mind that the tuned (leveraged) strategy is trading with hindsight in order to demonstrate the problem described above which specifically applies to the Volatility Risk Premium Strategy (but probably not limited to).

Image III – Summary Statistics
(03/25/2004 – 10/15/2014)

Possible solutions to fix the problem concerning (relatively) low historical volatility / rising (rocketing) implied volatility when / as long as apropriate (this time without hindsight):

  • leveraging the respective historical volatility,
  • increasing the cut-off (increasing the ‘1’) – triggering “long volatility” more frequently,
  • shortening the x-day moving average (in order to get the system to react more quickly),

to be continued … (means more on this to come, stay tuned)

__________________

Have a profitable week,

Frank


Disclosure: I’am long/short XIV, and long/short VIX, RVX and EURO STOXX 50 volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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Trading The S&P 500 Index (via Implied vs. Historical Volatility) http://www.tradingtheodds.com/2014/11/trading-the-sp-500-index-via-implied-vs-historical-volatility/ http://www.tradingtheodds.com/2014/11/trading-the-sp-500-index-via-implied-vs-historical-volatility/#comments Sun, 23 Nov 2014 18:10:55 +0000 http://www.tradingtheodds.com/?p=41890 A couple of weeks ago I started a series of postings, all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX® (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due […]]]>

A couple of weeks ago I started a series of postings, all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX® (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due to its exceptional performance – at least until December 2012 – and its compelling approach (from the paper Easy Volatility Investing from Double-Digit Numerics).

Since then there not only has been a discussion (comments section of the blogs mentioned later on) about data mining and curve-fitting (among others), which has been adressed and investigated by Ilya Kipnis on his (highly recommended) blog QuantStrat TradeR and the guy behind Volatility Made Simple (likewise highly recommended), but about the shrinking premium of VIX® front month futures (1st and 2nd month) vs. the VIX® index and the (future) doubtful tradability and potential trashiness of the Volatility Risk Premium Strategy as well (please note: DDN’s VRP Strategy (original) is currently undergoing a severe drawdown).

At least with respect to the time frame under review, I absolutely disagree.

Trading XIV® and VXX® not only means trading volatility as an underlying (VIX® front month futures, 1st and 2nd month), but trading a higly volatility asset itself, leverage (the ratio of the average daily movement of the S&P 500® index and VIX® front month futures (1st and 2nd month) is at/around 4, between S&P 500® index and VIX® index at/around 5.5) and time (risk) premium/time decay (regularly selling volatility/buying XIV® in order to harvest the premium associated). So how would VRP systems have performed and results be different if the S&P 500® index had been traded (instead of XIV® and VXX®) using VRP system signals for timing purposes, and therefore which part of VRP’s strategy performance(s) can be accounted to the strategies quality of forecast (S&P 500® index movements), and which part to buying/selling time (risk) premium/time decay ?

“How would VRP System results be different if SP500 L/S were to be traded using the VXX and XIV signals? (For VXX, go Short SP500, and for XIV go Long SP500).”

“Future returns will depend on the shrinkage/expansion of this premium. If the cake is gone ( or the pie much smaller so to speak ) , it’s gone ! No clever optimization will change this fact.” “The VRP has been zero or negative most of the year. … So VRP strategy returns should be zero.”

But first of all the original and revised Volatility Risk Premium (VRP) Strategy rules (always market on close):

  • Long S&P 500® : 5-day average of [VIX® | VXMT® – (10 | 2-day historical volatility of SPY | S&P 500 * 100)] > 0
    (Please note: Before 2008, VIX® instead of VXMT® is used)
  • Short S&P 500® : 5-day average of [VIX® | VXMT® – (10 | 2-day historical volatility of SPY | S&P 500 * 100)] < 0
  • Hold until a change in position.

Image I shows the respective equity curves (always trading the S&P 500® index, no leverage used, and always being ‘all in‘), DDN’s Volatility Risk Premium Strategy (original strategy) (red line, using a 10-day historical volatility), the VXMT® index version with a 2-day historical volatility (blue line), my own strategy, see PORTFOLIO & TRACK RECORD (black line), and a buy&hold (S&P 500® Index) approach (grey line). Please note: The CBOE provides VXMT® historical data back to 1/8/2008. Before 2008, VIX® has been used instead.

 

Image I – Trading the S&P 500® Index – Total Equity Curve(s)
(03/25/2004 – present)
(slippage, fees and transaction costs are assumed to total 0.05% per trade, 0,1% per round-trip)

From 3/25/2004 to 09/2008, all strategies were more or less dead even, while out-/underperformance startet (continuously accelerating) at the same time when the S&P 500® went into free fall during the financial crisis. Although this time DDN’s VRP Strategy trading the S&P 500® does not undergo a severe drawdown like it currently does trading VXX® and XIV® , it startet to flatten out one and a half year ago while the S&P 500® as well as all other counterpart strategies (trading the S&P 500®) went straight up (reason for the flat performance: a subpar 10-day historical volatility as already mentioned in my previous postings).

Image II shows the respective statistics for those strategies mentioned above.

 (click on image to enlarge)

Image II – Trading the S&P 500® Index via Implied vs. Historical Volatility
(03/25/2004 – present)

 

Next step/question: Having been stripped off it’s leverage and time (risk) premium (just up and down index movements), how would VRP systems have performed and results be different if a leveraged S&P 500® index ETF/ETN had been traded (instead of XIV® and VXX®) using VRP system signals for timing purposes, in order to work out (approximation) which part of VRP’s strategy performance(s) can be accounted solely to buying/selling time (risk) premium/time decay ?

For simplification purposes I calculated the respective leverage as the ratio of the average daily movements of the S&P 500® index vs. VIX® front month futures (constant maturity, 1st and 2nd month futures), which is at/around 4 . And for demonstration purposes, a combination of the Volatility Risk Premium Strategy (trading the S&P 500® index) – VXMT® index version with a 2-day historical volatility and the S&P 500 RSI(2-day) indicator for indentifying oversold/overbought conditions (blue line) has been added as well in order to show how performance could have been improved (boosted) by adding a well known technical indicator.

The Volatility Risk Premium (VRP) Strategy rules in combination with the S&P 500 RSI(2-day) indicator are as follows:

  • Long S&P 500® : [ 5-day average of [VXMT® – (2-day historical volatility of S&P 500 * 100)] > 0 OR S&P 500®  RSI(2-day) < 1 ]
    AND S&P 500®  RSI(2-day) < 95
    (Please note: Before 2008, VIX® instead of VXMT® is used)
  • Short S&P 500® : otherwise …
  • Hold until a change in position.

Image III shows the respective equity curves (strategies trading the S&P 500® index – blue line and red line – have been leveraged by factor 4), the Volatility Risk Promium Strategy (trading VXX® and XIV®) – VXMT® index version with a 2-day historical volatility – (black line), the Volatility Risk Premium Strategy (trading the S&P 500® index) – VXMT® index version with a 2-day historical volatility in combination with the S&P 500 RSI(2) indicator – (blue line), the Volatility Risk Premium Strategy (trading the S&P 500® index) – VXMT® index version with a 2-day historical volatility – (red line), and a buy&hold (XIV®) approach (grey line).

 

Image III – Volatility Risk Premium Strategy (Market Timing)
(03/25/2004 – present)
(slippage, fees and transaction costs are assumed to total 0.05% per trade, 0,1% per round-trip)

 

Image IV shows the respective statistics for those strategies mentioned above.

 (click on image to enlarge)

Image IV – Volatility Risk Premium Strategy (Market Timing, Leverage Factor 4)
(03/25/2004 – present)

From my perspective even with a shrinkage of time/risk premium, the Volatility Risk Premium Strategy rules can be useful (for market timing purposes) and highly profitable trading the S&P 500® index instead of trading XIV® and VXX® due to its (superb) quality of forecasting major market index movements. Although I’d still prefer trading XIV® and VXX® , for example adding the S&P 500® RSI(2-day) shows that trading the S&P 500® performance figures could be (further) improved not necessarily by adding any additional rule(s) and/or parameter(s), but by playing around with the existing set of parameters as well (x-day historical volatility, y-day moving average, the threshold/cutoff, …).

 

__________________

Have a profitable week,

Frank


Disclosure: I’am long/short VXX, and long/short VIX, RVX and EURO STOXX 50 volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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DDN’s Volatility Risk Premium Strategy Revisited (3) http://www.tradingtheodds.com/2014/11/ddns-volatility-risk-premium-strategy-revisited-3/ http://www.tradingtheodds.com/2014/11/ddns-volatility-risk-premium-strategy-revisited-3/#comments Sat, 15 Nov 2014 18:35:22 +0000 http://www.tradingtheodds.com/?p=41843 A couple of weeks ago I started a series of postings, all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due […]]]>

A couple of weeks ago I started a series of postings, all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due to its exceptional performance – at least until December 2012 – and its compelling approach (from the paper Easy Volatility Investing from Double-Digit Numerics).

In my last posting DDN’s Volatility Risk Premium Strategy Revisited (2) I introduced the CBOE Mid-Term Volatility Index (Ticker: VXMT®) as a proxy for implied volatility (expected volatility of the S&P 500 Index over a 6-month time horizon), which shows much better results than using the CBOE Volatility Index (Ticker: VIX®). But there is a catch: the VXMT® ‘s outperformance ended in June 2013 (more on that below).

But first of all the original Volatility Risk Premium (VRP) Strategy rules (always market on close):

  • Long XIV: 5-day average of [VIX® or VXMT® – (2-day historical volatility of S&P 500 * 100)] > 0
    (Please note: Before 2008, VIX® instead of VXMT® is used)
  • Long VXX: 5-day average of [VIX® or VXMT® – (2-day historical volatility of S&P 500 * 100)] < 0
  • Hold until a change in position.

Image I shows the respective equity curves, DDN’s VRP (original strategy) (red line, using a 10-day historical volatility), the VIX® index version (blue line) and the VXMT® index version (black line). The yellow area shows the VXMT® ‘s index version percentage-wise outperformance compared to the VIX® index version.

Please note: The CBOE provides VXMT® historical data back to 1/8/2008. Before 2008, VIX® has been used instead (therefore both strategies do not differ before 1/7/2008). The VXMT® index version outperformed it’s counterpart by a wide margin (topping out in June 2013), but has given back half of its percentage-wise outperformance since then. The question is: What is the reason behing the VXMT® ‘s index version decline in performance relative (not in absolute terms) to the VIX® index version ?

Image I – Total Equity and Drawdown Curve(s)
(03/25/2004 – present)
(slippage, fees and transaction costs are assumed to total 0.1% per trade)

 

The reason for the breakdown in performance ( DDN’s VRP Strategy ) and the out-/underperformance of the VXMT® ‘s index version relative to the VIX® index version imay be many-faceted, e.g. changes in the relationship between VIX® and VXMT® (ratio and/or premium, backwardation and contango, …), the relationship between implied and realized volatility, premium of VIX front and second month futures (as a basis for VXX® and XIV® ), among others.

Image II may present some insights and a first indication and shows:

  • relationship/delta of VIX® and VXMT® strategy triggers (for going long or short volatility):
    5-day moving average of [VIX® – 2-day historical  volatility of S&P 500 * 100]     
    5-day moving average of [VXMT® – 2-day historical  volatility of S&P 500 * 100]
  • Volatility Risk Premium (potential gain):
    1-month moving average of [VX1|VX2 (30-day const. maturity) – 2-day historical  volatility of S&P 500 * 100]
  • the S&P 500®Index

 

Image II – Volatility Risk Premium and VIX® vs. VXMT®
(01/07/2008 – present)

Right at the start of the bull market in 2009 (at the end of the financial crisis), VIX® front and second month futures (Ticker: VX1|VX2) (merged into a continual time series as a 30-day constant-maturity futures prices, as they are the basis for VXX® and XIV®) were trading at a huge premium to the then current realized (2-day historical) volatility, but as investor complacency grew into the ongoing bull market, the delta between realized and implied volatility faded and is now merely at half the levels of 2009.

The same reason, but a different effect: While at first (2009) the VIX® index came down from historical high levels back to historically normal levels (from backwardation into contango), 6-month looking forward implied volatility (VXMT®) remained relatively flat, reverting a positive spread between VIX® and VXMT® into a widening negative one. But that trend was reversed in 2012. As investor complacency grew, 6-month looking forward implied volatility (VXMT®) was (and still is) on the wane. (Looking forward) Volatility slumps as complacency regains the upper hand.

Between 2009 and the end of 2012, every up-move in the markets was accompanied by a widening spread (regularly up to -7-8 percentage points) between VIX® and VXMT® (investor scepticism remaind relatively high), but since January 2013 the (averaged) spread between VIX® and VXMT® has remained well below -5 (percentage points). For examplary purposes: With VIX® at or around 13, it is like VIX futures with a 6 month maturity would’ve been trading at or around 21 in 2009, while they’re trading below 18 today. Means investor fear looking 6 month ahead is currently at significantly lower levels than it had been in 2009.

Image III now shows the relationship between implied (VXMT® index as expected volatility of the S&P 500 Index over a 6-month time horizon) and historical (annualized, 2-day realized) volatility.  Since 2013, the gap has remained flat (constant) at historically low levels at or around -15%.

 

Image III – VXMT® and Historical Volatility
(01/07/2008 – present)

 

Due to the fact that the gap between implied volatility and historical (realized) volatility remained constant/flat over the course of the last year and a half, the Volatility Risk Premium Strategy utilizing the VXMT® index was at a disadvantage compared to it’s VIX® counterpart : With volatility of volatility dwindling away, the “5-day average of [VXMT® – (2-day historical volatility of S&P 500 * 100)] > 0” remained almost constant/flat in positive territory and closed below ‘0’ (trigger value for going long volatility) less often than before June 2013 (to be exact: now in 1 out of 30 sessions only instead of 1 out of 10 sessions before), means it mimics more or less a Buy&Hold XIV® strategy instead of taking benefit of both sides of the trade (assumed going long volatility after 6/30/2013 had been as profitable as it had been before 6/30/2013). By contrast the VIX® based strategy remained (almost) unaffected (because the VIX® is trading a couple of index points below the VXMT® index), still going long volatility in approximately 1 out of 10 sessions.

Image IV shows the distribution of the results of the formula “5-day average of [VXMT® – (2-day historical volatility of S&P 500 * 100)] > 0” , overall, before and after 6/30/2013.

Image IV -Distribution of Trigger Values
(01/07/2008 – present)

 

Possible solutions to fix that problem:

  • using a different cutoff (other than ‘0’),
  • using a different x-day historical volatility and/or y-day moving average,
  • making the system adaptive (incorporating a learning curve, from my perspective the most interesting approach),

to be continued … (means more on this to come, stay tuned)

__________________

Have a profitable week,

Frank


Disclosure: I’am long/short XIV, and long/short VIX, RVX and EURO STOXX 50 volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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DDN’s Volatility Risk Premium Strategy Revisited (2) http://www.tradingtheodds.com/2014/11/ddns-volatility-risk-premium-strategy-revisited-2/ http://www.tradingtheodds.com/2014/11/ddns-volatility-risk-premium-strategy-revisited-2/#comments Tue, 11 Nov 2014 18:07:12 +0000 http://www.tradingtheodds.com/?p=41816 A couple of days/weeks ago I started a series of postings ( Volatility Risk Premium – Trading Volatility (Part I) ), all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was […]]]>

A couple of days/weeks ago I started a series of postings ( Volatility Risk Premium – Trading Volatility (Part I) ), all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due to its exceptional performance – at least until December 2012 – and its compelling approach (from the paper Easy Volatility Investing from Double-Digit Numerics).

Although the strategy has delivered some extraordinary results between 2004 (data prior to the launch of ETFs/ETNs has been simulated, data source: SIX FIGURE INVESTING) and 2012, the more notable is the decline in performance since the end of 2012 (to be exact: the strategy is currently down -45.54% from its last peak in net asset value on 10/18/2012, for 629 days up to now).

This time I’ll show two different solutions to fix the recent decline in performance, replacing the VIX® (CBOE Volatility Index) by utilizing two different but related underlyings:

  • CBOE Mid-Term Volatility Index (Ticker: VXMT®), with a 6-month time horizon
  • VIX® front and second month futures (VX1|VX2), merged into a continual time series as constant-maturity futures price

But first of all the original Volatility Risk Premium (VRP) Strategy rules (always market on close):

  • Long XIV: 5-day average of [VIX index – (10-day historical volatility of SPY * 100)] > 0
  • Long VXX: 5-day average of [VIX index – (10-day historical volatility of SPY * 100)] < 0
  • Hold until a change in position.

As already discussed in some detail in my first posting of this series, using a 10-day historical volatility – additionally smoothed by a 5-day moving average – is probably too slow to react on (sudden) changes/swings in the market, while it performs (extraordinary) well during trending markets. I therefore always use a 2-day (day-to-day) historical volatility.

I wanted to follow Double-Digit Numeric’s approach not to add any additional and/or specific threshold (leave alone any additional rule) in oder to avoid “a visit from the Grim Reaper” (from the paper Easy Volatility Investing from Double-Digit Numerics).

Image I shows the respective equity curves, DDN’s VRP (original strategy) (red line), the VX1|VX2 (constant-maturity) version (blue line) and the VXMT® index version (black line), as defined by:

  • Long XIV: 5-day average of [VXMT® – (2-day historical volatility of S&P 500 * 100)] > 0
    (Please note: Before 2008, VIX® instead of VXMT® is used)
  • Long VXX: 5-day average of [VXMT® – (2-day historical volatility of S&P 500 * 100)] < 0
  • Hold until a change in position.
  • Long XIV: 5-day average of [VX1|VX2 – (2-day historical volatility of S&P 500 * 100)] > 0
  • Long VXX: 5-day average of [VX1|VX2 – (2-day historical volatility of S&P 500 * 100)] < 0
  • Hold until a change in position.

Obviously, using a 2-day historical volatility in combination with replacing the VIX® by the VXMT® not only solves the problem regarding the recent decline in performance (since 12/2012), it startet it’s outperformance already in 2008 during the financial crisis and never looked back.

Image I – Total Equity and Drawdown Curve(s)
(03/25/2004 – present)
(slippage, fees and transaction costs are assumed to total 0.1% per trade)

 

Image II shows the respective statistics for all of those strategies mentioned above.

 (click on image to enlarge)

Image II – Summary Statistics
(03/25/2004 – present)

 

Image III shows the respective monthly and annual performance (VRP with 2-day historical volatility and VXMT®).

 

(click on image to enlarge)

Image III -Monthly and Annual Returns (VRP w/ VXMT)
(03/25/2004 – present)

__________________

 

Have a profitable week,

Frank


Disclosure: I’am long/short VXX, VIX, RVX and EURO STOXX 50 volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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DDN’s Volatility Risk Premium Strategy Revisited http://www.tradingtheodds.com/2014/11/ddns-volatility-risk-premium-strategy-revisited/ http://www.tradingtheodds.com/2014/11/ddns-volatility-risk-premium-strategy-revisited/#comments Thu, 06 Nov 2014 21:59:49 +0000 http://www.tradingtheodds.com/?p=41793 A couple of days/weeks ago I started a series of postings (  Volatility Risk Premium – Trading Volatility (Part I) ), all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was […]]]>

A couple of days/weeks ago I started a series of postings (  Volatility Risk Premium – Trading Volatility (Part I) ), all dealing with trading volatility ETNs / ETFs like XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (Double-Digit Numerics , Volatility Risk Premium) due to its exceptional performance – at least until December 2012 – and its compelling approach (from the paper Easy Volatility Investing from Double-Digit Numerics).

Although the strategy has delivered some extraordinary results between 2004 (data prior to the launch of ETFs/ETNs has been simulated, data source: SIX FIGURE INVESTING) and 2012, the more notable is the decline in performance since the end of 2012 (to be exact: the strategy is currently down -48.27% from its last peak in net asset value on 10/18/2012, for 625 trading days up to now). The million dollar question is: The reason behind the most recent decline in performance, and an easy way to fix it avoiding the common pitfall of curve fitting.

First of all the original Volatility Risk Premium (VRP) Strategy rules (always market on close):

  • Long XIV: 5-day average of [VIX index – (10-day historical volatility of SPY * 100)] > 0
  • Long VXX: 5-day average of [VIX index – (10-day historical volatility of SPY * 100)] < 0
  • Hold until a change in position.

I wanted to follow Double-Digit Numeric’s approach not to add any additional and/or specific threshold (leave alone any additional rule) in oder to avoid “a visit from the Grim Reaper” (from the paper Easy Volatility Investing from Double-Digit Numerics), and fotunately there is an elegant solution to this problem. First of all I checked for the impact of the “5-day average of …” (if any) to the strategy’s statistics (overall return of investment, drawdown, Ulcer Performance Index, …).

Image I shows the respective equity curves, DDN’s original strategy (red line) and a revised version (blue line) using the following modifcation (the “5-day average of” has simply been deleted without replacement):

  • Long XIV: VIX index – (10-day historical volatility of S&P 500 * 100)] > 0
  • Long VXX: VIX index – (10-day historical volatility of S&P 500 * 100)] < 0
  • Hold until a change in position.

Although the revised strategy underperforms the original strategy between 2007 and 2013, it significantly outperforms it’s counterpart for the last year and a half (see the drawdown curve below, the green area on the top of the chart shows the revised strategie’s outperformance) and makes up for any deficit of the past.


Image I – Total Equity Curve
(03/25/2004 – present)
(slippage, fees and transaction costs are assumed to total 0.1% per trade)

 

Image II shows the respective statistics.

 


Image II – Summary Statistics
(03/25/2004 – present)

 

To make a long story short, image III shows the respective equity curves as well as time, duration and severity of respective drawdowns (including the revised strategy’s advantage/disadvantage compared to the original strategy) in the event the “10-day historical volatility of S&P 500” would’ve been replaced by a “7-day historical volatility of S&P 500″, which makes the revised strategy looks like (please note: no moving average is being used, and the threshold remains “0”):

  • Long XIV: VIX index – (7-day historical volatility of S&P 500 * 100)] > 0
  • Long VXX: VIX index – (7-day historical volatility of S&P 500 * 100)] < 0
  • Hold until a change in position.


Image III – Total Equity Curve
(03/25/2004 – present)

Image IV shows the respective statistics. The revised strategy (using a 7-day historical volatility, no moving average, and the threshold remains “0”) is not only superior to it’s original counterpart in (almost) every respect (annualized return, max. drawdown, time in drawdown, Ulcer Performance Index), it would’ve performed perfectly well especially during the last year and a half.

(click on image to enlarge)


Image IV – Summary Statistics
(03/25/2004 – present)

 __________________

Next time I’ll dig a bit deeper into the reason behind the original strategy’s decline in performance since the end of 2012.

Have a profitable week,

Frank


Disclosure: I’am long/short VIX, RVX and EURO STOXX 50 volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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Trading Volatility – XIV Seasonalities http://www.tradingtheodds.com/2014/11/trading-volatility-xiv-seasonalities/ http://www.tradingtheodds.com/2014/11/trading-volatility-xiv-seasonalities/#comments Sun, 02 Nov 2014 18:57:51 +0000 http://www.tradingtheodds.com/?p=41775 This is a another follow up to my previous postings Volatility Risk Premium – Trading Volatility (Part I) to Volatility Risk Premium – Trading Volatility (Part III) and Trading Volatility – Some XIV and VXX (Ir)Regularities,  this time dealing with some intersting seasonalities concerning the XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX® (iPath® S&P […]]]>

This is a another follow up to my previous postings Volatility Risk Premium – Trading Volatility (Part I) to Volatility Risk Premium – Trading Volatility (Part III) and Trading Volatility – Some XIV and VXX (Ir)Regularities,  this time dealing with some intersting seasonalities concerning the XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX® (iPath® S&P 500 VIX Short-Term Futures™ ETN). Some food for thought over the remainder of the weekend.

Image I shows the distribution of returns holding long XIV® the last two days before (VIX® futures and options) expiration, when VIX® futures completely erase all of it’s remaining premium. XIV® shows a remarkable average (daily) gain of +0.66% on both days, compared to an average gain of +0.12% on all other days (3+ days to expiration).


Image I – Distribution of Returns w/ x Days to Expiration (XIV)
(03/25/2004 – present)

Image II shows the distribution of returns holding long XIV® on a FOMC announcement day. XIV® shows a whopping average gain of +1.71% on those announement days (due to the fact that VIX® itself shows a regular tendency to close – partly significantly – lower on these days when market participants relieve tension), compared to an average gain of +0.12% on all other days.

 


Image II – Distribution of Returns on FED Announcement Day (XIV)
(03/25/2004 – present)

Image III shows the distribution of returns holding long XIV® on the first three days of a month (start of month) when money managers are supposed to put fresh money at work. XIV® shows a remarkable average gain of +0.39% on those days, compared to an average gain of +0.15% on all other days. “Don’t fight the FED.” (as being long VXX® – iPath® S&P 500 VIX Short-Term Futures™ ETN – these days would simply be a recipe for disaster). You probably know this old adage.


Image III – Distribution of Returns on Day 1 – 3 of the Month (XIV)
(03/25/2004 – present)

Image IV shows the distribution of returns holding long XIV® the day after a business holiday (NYSE Closing). XIV® shows (again) a remarkable average gain of +0.43% on those days, compared to an average gain of +0.16% on all other days.

 


Image IV – Distribution of Returns the Day Following a NYSE Closing (XIV)
(03/25/2004 – present)

And last but not least image V shows the distribution of returns holding long XIV® at the end of the month, in this example/event on the 30th and 31st calendar day of a month. XIV® shows a striking average loss (!) of -0.40% on those days, compared to an average gain of +0.20% on all other days.

 


Image V – Distribution of Returns on Day 30 – 31 of the Month (XIV)
(03/25/2004 – present)

 __________________

 

Have a profitable week,

Frank


Disclosure: I’am long/short VXX®, VIX®, RVX® and EURO STOXX 50® volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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Trading Volatility – Some XIV and VXX (Ir)Regularities http://www.tradingtheodds.com/2014/10/trading-volatility-some-xiv-and-vxx-irregularities/ http://www.tradingtheodds.com/2014/10/trading-volatility-some-xiv-and-vxx-irregularities/#comments Thu, 30 Oct 2014 21:17:47 +0000 http://www.tradingtheodds.com/?p=41758 This is a (short) follow up to my previous postings Volatility Risk Premium – Trading Volatility (Part I) to Volatility Risk Premium – Trading Volatility (Part III) , this time dealing with some intersting (ir)regularities concerning the XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX® (iPath® S&P 500 VIX Short-Term Futures™ ETN). Some food […]]]>

This is a (short) follow up to my previous postings Volatility Risk Premium – Trading Volatility (Part I) to Volatility Risk Premium – Trading Volatility (Part III) , this time dealing with some intersting (ir)regularities concerning the XIV® (VelocityShares Daily Inverse VIX Short-Term ETN) and VXX® (iPath® S&P 500 VIX Short-Term Futures™ ETN). Some food for thought over the weekend.

Image I shows the respective distribution of returns holding long XIV® (VelocityShares Daily Inverse VIX Short-Term ETN), and trading long XIV® in the event (and as long as) the S&P 500 2-day RSI closes below 5 (so called ‘oversold conditions’) and above 95 (so called overbought conditions). Not surprisingly returns are skewed to the left in the event selling short volatility (long XIV®) when the market already had a strong run up (2-day RSI > 95). The opposite applies in the event selling volatility when the market had sold off (2-day RSI < 5). Returns are (significantly) skewed to the right, and XIV® gained between 1% and 5% in 4 out of 10 occurrences.


Image I – Distribution of Returns (XIV)
(03/25/2004 – 10/29/2014)

Image II shows the median (not the average, which is skewed by outliers on both ends) gain with respect to the day of the week. My first thought was it should be the Friday which shows the biggest gain due to the VIX® and VIX® futures regular behaviour to close lower before the weekend. Far wrong …

 


Image III – Median Gain / Loss w/ Day of Week
(03/25/2004 – 10/29/2014)

 

Image II shows the median (not the average, which is again skewed by outliers on both ends) gain with respect to the days to expiration (VIX® futures and options). This image gives a good impression why holding VXX® long term is such a lousy investment. Not surprisingly XIV® performs very well the last two days before expiration (VIX futures remove any remaining premium).


Image III – Median Gain / Loss w/ Days to Expiration
(03/25/2004 – 10/29/2014)

__________________

 

Have a profitable week,

Frank


Disclosure: I’am long/short VXX®, VIX, RVX and EURO STOXX 50 volatility futures.

________________________________

Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments.

________________________________

Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock and Pinnacle Data Corp., and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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