Here's a "simple" strategy that i discovered while researching volatility products such as XIV, VXX, etc. Im not an expert when it comes to volatility, but i've found that strategy very interesting and did some tests on it. There's seems to be numerous strategies out there that use volatility products to produce alpha. Some of of them can produce remarkable returns, however , huge drawdowns are often associated with those return. However the strategy below, which uses VVIX ( VIX or VIX ) , is simple and can be easily implemented by anyone.
VIX of VIX !
As mentioned, this strategy uses VVIX. So what is VVIX ? VVIX or VIX of VIX , measures the volatility of the VIX index. The VIX index measures the volatility of the S&P 500, and VVIX measures the volatility of the VIX. Got it ? Good ! . Below , we can see a VVIX ( green) compared to (VIX).
So how this strategy works ? it's simple. Each time the VVIX reaches "extreme" levels, we want to buy XIV. XIV is an ETN created by VelocityShares, that track the inverse of VIX. "Extreme" levels for VVIX is 90 + . Once the VVIX goes below 90, we want to close our position in XIV. That is it. Let's test those rule's and take a look at the results. commission and other fees are excluded from this test.
VVIX > 90
VVIX < 90
Let's take a look at the results. Total return from 2011 till this Friday ( 2/17/2017) is 305.41 %, Max Drawdown of 74 %, sharpe ratio of 0.55 , W/L profit ratio of 1.63. Not bad !
As you can see from the graph above , the equity curve is all over the place, and with a Max DD of 73 % , this is beyond the pain threshold of the most aggressive investor. However, if we find a way to decrease the drawdown, this strategy may become more appealing.
What if ?
What will happen if we wanted to trade this strategy during uptrend in the market. We've already cover how to identified these periods in my previous blog post. So now we want to buy XIV if VVIX is above 90 AND SPY ( S&P 500 ETF) above its 10 months MA, and sell if VVIX is below 90 OR if SPY is below its 10 months MA .
VVIX > 90 AND
SPY > 10 month MA ( SPY)
VVIX < 90 OR
SPY < 10 month MA ( SPY)
Looking at the equity curve alone , we can see this version of the strategy is much more stable than the previous. Total return for the the same period is 223.21 % , Max Drawdown of 25.70 % , which is a lot more reasonable than 73 %, a sharpe ratio of 0.83, and a W/L profit ratio of 2.13.
So with this version of the strategy , we are sacrificing return to get a more stable strategy by reducing the drawdown by 65 %.We are also increasing the W/L ratio by 30 %.
Can I Trade this ?
Yes , this strategy can be traded, however please keep the following in mind :
Not enough data : Although the XIV ETN has been available since late 2010, there's simply not enough data to see how it would perform during bear markets and crisis just like we had in 2008.
Delayed data: The VVIX data is only updated at the end of day, therefor the signal will only generated the nigh of , or the next morning.
Drawdown: Despite lowering the drawdown by 65 % , this strategy is still very aggressive. With a current drawdown of 25 %, only very brave investors should allocate money to this strategy.
I really like strategies that use simple rules to generate positive return. This is strategy can be a lot better, I'm already working on another version with very promising results. I encourage you to take the information in this article and test it yourself, and to please share your finding with me if you have the time .