Most of you probably read the New York Times Article published last week, about a former Target store manager who turned $500,000 into $12 million, using one of Wall Street's favourite trade, shorting the VIX. So how did he do it ??? I may have an idea how.
Shorting the VIX is not a new idea, but its is a trade that works well.......until it doesn't. So how do you turn $500,000 into $12 millions in five years ? Well for starters you take A LOT of risk. Mr. Golden, the former Target store manager must have nerves of still for putting so much money on the line, but the reward however is fantastic. There's many strategies that you could use to short VXX. Some very complex, other very simple. I will use a simple strategy for this post.
Moving averages strategies are some of the easiest strategies for investors to follow .We'll use moving average crossover for our strategy . To short the VIX, we'll use VXX. Let's take a quick look
As you can see , VXX is in a downtrend most of the time. This is encouraging as it confirms that taking a short position is the best way to go . Let's now add our moving averages. I will use the 5 day and 15 day moving averages for this strategy. The trading rules are pretty straight forward.:
Short : When 5 ma < 15 ma
cover: When 5 ma > 15 ma
Place the trade the next day. That's it !!
Just looking at the chart, we can see that this strategy has some potential. Let's see what type of result we get with this. We 'll test this strategy with the following criteria
- Period : Jan 2012, till September 1, 2017.
- Starting capital : $500,000
- Commission, Borrowing fees, and slippage are ignored for this test.
- Return : 422.62 %
- Ann. Return : 34 %
- Profit : $2,113,100.95
- Max DD : 41 %
# of Trades : 38
W : 15
L : 23
Sharpe Ratio :1.00
Not bad ! , not quite the $12 million we are looking, but still delivers some acceptable results. We end up with a total of $2,613,100.95.
A few thing to consider here :
Borrowing Fees : when you short, you borrow shares from your broker, there for you will pay interest on the value borrowed. the average borrowing fee for VXX, also referred as neg fee, is about 2.24 % per year.
Drawdown : Most investors want to avoid drawdowns of 20 % or more before cutting their losses. This strategy had a maximum drawdown of 41 %, which is extreme for most investors, but quite the norm for volatility strategies.
So this experiment shows us ( in theory) that it is possible to make a nice chuck of change shorting the VXX, even though we weren't able to replicate the same results as Mr. Golden. If we do not want short we could use the same strategy with XIV, which is the inverse of VXX.
As always, these blog posts shouldn't be treated as advice. Make sure to read the Disclaimer section.