VXX/XIV Pairs Trade? (An Unfinished Thought)
I put “tracks” in quotes because there are fundamental issues with both ETFs that mean they don’t actually follow the VIX all that well (read more from VIX & More).
But despite tracking the VIX badly, VXX and XIV have tracked each other’s inverse pretty closely. In the graph below I’ve assumed that we were long 50% VXX and 50% XIV, rebalanced daily at the close (frictionless), from 12/01. Because VXX is long and XIV short the VIX, this is a pairs-trade of sorts.
Geek note: XIV acted strangely in its first couple of days of trading so I’ve started the graph above on 12/01. Weird starts are common in new indexed products – chalk it up to working out the kinks.
The pair has (so far) oscillated around a flat line, but occasionally deviated sharply, possibly offering a pairs-trading’esque opportunity.
In the graph below I’ve applied to a 10-day moving average to the “neutral” pair shown above and assumed we went “long” (long VXX/long XIV) at the close when the neutral pair was below the MA, and “short” (short VXX/short XIV) when above. Results are frictionless.
In this hypothetical world, the strategy has been uber effective, returning roughly 61% annualized with 76% of all days positive. Note: there’s nothing special about 10-days; any MA length has been similarly effective.
There are three reasons though that this is an unfinished thought and I’m not all that excited (yet) about the results:
1. Both VXX and XIV are difficult to short, so playing the “short” side of the trade would be difficult (having said that though, the “long” side of the trade has actually been the more effective of the two).
2. A bit of slippage wouldn’t have killed the strategy (there’s a lot of meat in these returns), but it’s definitely a concern, especially for XIV which is, for the moment, not very liquid.
3. And the most obvious, with just two months since XIV launched, there just isn’t enough data (yet) to assume that this relationship is going to hold or that these sharp deviations between the two ETFs will continue once XIV liquidity improves.
I mention the idea here as brain food and to keep it on the radar as something to revisit in the future. As always, more to follow!
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Filed under: Trading Strategies, VIX & Volatility | 9 Comments