A couple of weeks ago I started a series of postings, all dealing with trading volatility ETNs / ETFs like XIV
®(VelocityShares Daily Inverse VIX Short-Term ETN) and VXX (iPath® S&P 500 VIX Short-Term Futures™ ETN) and respective trading strategies. One of those strategies was DDN’s VRP Strategy (
Double-
Digit
Numerics ,
Volatility
Risk
Premium) due to its exceptional performance – at least until December 2012 (original version) – and its compelling approach (from the paper Easy Volatility Investing from Double-Digit Numerics).
Since then a couple of bloggers have taken up this issue (VRP) as well ( e.g. Volatilty Made Simple , Trading Volatility , QuantStrat TradeR , Evolution Trading , among others), some offering their services (including a VRP strategy) and insights for free while others are subscription based. If you’re interested in the topic, please check for their blogs (highly recommended).
Most recently Volatilty Made Simple had an interesting article ( here ) about the different measures of implied volatility (e.g. VIX®, VXMT®, VX 30-day constant maturity) I present over the course of the series of postings mentioned above, and he is completely correct when concluding 『that any advantage of one over the others is likely the result of random chance『. Fortunately I』ll show you that there is a huge but: 『average』 does not mean 『average』 , especially in combination with those different measures of implied volatility mentioned before.
But first of all the Volatility Risk Premium (VRP) Strategy rules (always market on close):
Long XIV: 5-day average of [VIX® – (2-day historical volatility of S&P 500 * 100)] > 0
Long VXX: 5-day average of [VIX® – (2-day historical volatility of S&P 500 * 100)] ≤ 0
Hold until a change in position.
Image I shows the respective equity curves when – this time – utilizing different kind of averages instead of different measures of implied volatility (with one exception to the rule):
black line : Inverse Distance Weighted Moving Average (IDWMA)
grey line : Distance Weighted Moving Average (DWMA)
blue line : Simple Moving Average (SMA)
orange line : Exponential Moving Average (EMA)
green line : Exponential Moving Average, utilizing VIX® futures VX1|VX2 , merged into a continual time series as a 30-day constant-maturity futures price ( the underlying for VXX® and XIV® ), and using 1 instead of 0 as cutoff.
Utilizing the VX1|VX2 cont. contract in combination with an (5-day) exponential moving average and 1 as cutoff outperforms all other averages by a wide margin and way beyond any S&P 500 / XIV® buy-and-hold strategy (but please note: these are all hypothetical – not actual trading – results, based on partly simulated VXX® and XIV® data), despite the fact that it – up to now – doesn’t use any kind of position sizing and/or money management (the strategy is always all-in), no intraday buy/sell stops (end-of-day prices and orders only), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), the strategy is not adaptive (do not adjust to the ongoing changes in market conditions like bull and bear markets), there is no over-optimization (e.g. by applying additional rules for seasonalities like FED announcement days, the last 2 days before maturity, S&P 500 overbought/oversold conditions, among others), and none of those findings presented before on this blog are applied, and and and.
Image I – Total Equity Curve(s)
(03/26/2004 – present)
Image II – Drawdown Curve(s)
(03/26/2004 – present)
Image III shows the respective statistics (key figures) side by side.
(click on image to enlage)
Image III – Statistics – Sidy by Side Comparison
(03/26/2004 – present)
And last but not least monthly and annual returns (despite the German term for the respective months, I think you get the picture).
(click on image to enlage)
Image IV – Performance Summary – Monthly and Annual Returns
(03/26/2004 – present)
This will for sure not be my last posting dealing with the Volatility Risk Premium Strategy. From my perspective still the biggest hurdle to overcome are those periods in time when implied volatility (investor fear) is on the rise while realized volatility remains relatively calm, forcing the strategy to stay long XIV® (short volatily) way too long and driving the net asset value into a severe drawdown, like it happened most recently (since December 2014).
to be continued … (means more on this to come, stay tuned)
__________________
Have a profitable week,
Frank
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Disclosure: I』am long/short XIV, and long/short VIX, RVX and EURO STOXX 50 volatility futures.
________________________________
Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always 『all in『 – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not 『adaptive『 (do not adjust to the ongoing changes in market conditions like bull and bear markets). Index data (e.g. S&P 500 cash index) does not account for dividend and cash payments. The results are regularly based on simulated data and/or hypothetical performance and do not represent real trading.
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