Strategy #1 for Trading Volatility ETPs: Term-Structure Following


In my previous post I talked conceptually about 2 strategies I use for trading volatility ETPs like VXX and XIV. In this post I’d like to drill down on the first of those strategies: following the VIX futures term-structure.

As the chart below shows, most of the time the term-structure acts as a strong tailwind in favor of either trading short volatility (ex. short VXX/long XIV) or long.

The chart shows my estimate of the average daily impact that the VIX futures term-structure had on VXX over the previous 63-days (3 months). You can more or less flip these results for XIV.

For example, if the chart reads +0.5%, that means the term-structure boosted VXX (regardless of changes in the VIX) by 0.5% per day over that 3 months (or about 251% annualized).

Geek note: I’m using “term-structure” loosely to mean roll yield, time decay, and all other factors not directly related to immediate changes in the VIX itself.

I don’t want to share the math on this one because I think this is one of the competitive advantages of my model, but you could get in the ballpark simply comparing the first/second month futures contracts.

The Strategy

Keeping it really simple, let’s assume we bought VXX at the close when the values in the chart above were positive, and bought XIV when the values in the chart were negative. This is just a proof of concept, so I’m ignoring transaction costs/slippage.

[logarithmically-scaled, growth of $10,000]

This strategy is overly simple, but would still have put up impressive numbers: a 57% annualized return with only 8 trades per year, since 06/2004.

There’s clearly some low hanging fruit to improve results (like stop losses), but I think it proves the point nicely that simply following the VIX futures term-structure, and ignoring what’s happening with the underlying VIX, is a workable strategy.

As I mentioned in my last post, in my own trading I mix a term-structure following approach with one timing the underlying VIX itself.

More on this more advanced strategy in a future post.

Happy Trading,

. . . . .

To stay up to date with what’s happening at the MarketSci Blog, we recommend subscribing to our RSS Feed or Email Feed.

10 Responses to “Strategy #1 for Trading Volatility ETPs: Term-Structure Following”

  1. 1 db

    “…let’s assume we bought VXX at the close when the values in the chart above were positive, and bought XIV when the values in the chart were negative.”

    so when would you sell vxx or xiv or would you always have a position on?

    • 2 MarketSci

      Hello db: in my example above, there is always a position on (either VXX or XIV). Not how I actually approach the trade, just a simple illustration. michael

  2. 3 Don

    Great analysis.

  3. Very interesting back-test and I like your second strategy as well. In a similar vein, iPath recently launched a “Dynamic VIX ETN” which does something close to this strategy. It doesn’t go fully short volatility when the term structure is steep, but it does put on a sort of arbitrage play by going long the back end of the curve and short the front end where the roll cost is the most expensive.

    • 5 MarketSci

      Hello Elliott – I’m assuming you’re referring XVZ? You’re right, very similar conceptually to this strategy. michael

  4. 7 Daryl Roberts

    what are the inputs for the top graph? is there a live source for that? say at CBOE somewhere? or is that a proprietary analysis? the back test on following term structure looks great. how closely are actual returns on the combined technique tracking the backtest results?

    • 8 MarketSci

      Hello Daryl – it’s my own (proprietary) analysis, but you would reach similar results just comparing the first and second month VIX futures contracts. michael

  5. 9 rjdoublet D

    Hi Michael,

    Thank you for sharing your insights. I am currently tinkering around with volatility strategies. Out of interesting have you tried using VIX / VXV rather than VIX futures?


  1. 1 Wednesday links: no sure things | Abnormal Returns

Leave a Reply

Please log in using one of these methods to post your comment: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s