Trading Volatility ETPs: Obey Thy Stops
As I hope I made clear enough, these strategies were meant to be illustrative and are NOT ready for actual trading.
The most important element both strategies were missing was protective stops.
The nature of these ETPs means that your trade is less likely to move against you in tiny increments (like a dripping faucet) assuming that you stay on the right side of the VIX futures term-structure.
But at some point you will be on the wrong side of the trade when the VIX jumps (which overshadows the effect of the term-structure) and your position will move against you very quickly.
That’s especially true when you’re short volatility (ex. long XIV) because the VIX is much more prone to spiking up than down.
This “spiky” nature of the volatility ETPs means that protective stops are even more important than with most conventional assets.
I considered different ways to illustrate that point statistically, but I think a simple chart of XIV back to 2004 makes a better case than a number ever could. Note all of the crashes over just the last 8 years.
Geek note: read more about how I produced XIV returns back to 2004.
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Filed under: VIX & Volatility | 14 Comments