VIX: Naked Longshots
Jan 3, 2018
By: Sage Anderson
As 2017 drew to a close, it almost seemed fitting that the VIX dipped back below 10 - close to the lows of the year (and of all time, for that matter).
Sitting at 9.44 before Christmas, the VIX slipped toward its all-time low of 8.56, which it hit on November 24th of this year.
While the winter holidays in the United States typically see lower levels of volatility, the most recent dip below 10 feels a bit like the punch that comes right before the knock-out in a heavyweight boxing match.
After taking a whipping all year, volatility is on the mat, and it doesn't look like it's getting up anytime soon.
For additional context, consider the fact that the VIX got below 10 on 79 trading days during 2017, while the 27-year period from 1990 through 2016 only saw 44 such days.
That’s the thing about trading though - conditions can change, and quickly. While 2017 has seen nearly unprecedented tranquility in equity markets, things can change on a dime.
Therefore, in the contrarian spirit, imagine for a second that the VIX is poised to lift off, and that the financial markets are set to embark on a tumultuous period throughout 2018 - a hypothetical scenario, if there ever was one.
Now picture a trader that believes wholeheartedly in that hypothetical scenario, and views 2018 as a year when volatility returns with a vengeance. While there are many avenues that trader might take to express that view, let’s say for the purposes of this example that he/she wants to use the VIX.
One method of deploying such a view would be to purchase naked long calls in VIX, which theoretically increase in value as the VIX goes higher.
The question then is how such a strategy has performed historically. Luckily for us, the Market Measures team already crunched the numbers and presented them on a recent installment of the show.
Using data from 2006 to present, a study was designed that sought to evaluate the historical performance of continually purchasing 50-delta VIX calls in hopes of catching an upswing in volatility.
To evaluate a range of trading approaches, the backtest incorporated four different trade management methods: holding all positions until expiration, managing all positions at 50% of debit paid, managing all positions at 100% of debit paid, and managing all positions at 200% of debit paid.
Lastly, the results of the study were filtered twice - the first which included all occurrences throughout the period, and the second which included only instances when the VIX was trading below 15. The different filters were instituted to evaluate whether the strategy had a better chance at profitability when the VIX was trading toward to the lower end of its historical range.
The two slides below highlight the results of this comprehensive study. The first slide includes all occurrences, while the second slide includes only instances when the VIX was below 15:
As you can see in the graphics above, none of the trading approaches used in the study produced a positive average P/L (on average). Additionally, a win rate above 50% wasn’t achieved by any of the strategies, either.
Another important insight gleaned from this analysis is that the average P/L of all four trade management methods did improve when filtering only for instances in which the VIX was trading below 15 (as compared to all occurrences). However, the average P/L for this strategy was still net negative.
The above data is certainly pertinent for traders that are considering a long volatility approach in 2018. If one is looking to take a longshot in VIX, it’s probably better to do so when the VIX is depressed (sub-15) as compared to otherwise.
Traders looking for additional data relating to long premium strategies in low implied volatility environments may find another recent episode of Market Measures complementary to the above information. The topic of this show is the success rates of purchasing long premium in SPY during 2017, which saw some of the lowest implied volatility levels ever recorded.
If you have any questions above long VIX strategies, or long volatility in general, we hope you’ll leave a message in the space below, or reach out directly at email@example.com.
Happy new (trading) year!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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