Monthly Archives: March 2012
The Alpha strategy has performed beautifully so far this year. So nice to get a peaceful period after last year’s market violence.
I’m considering eliminating one of the rules of the strategy. The model currently hops into VXX if either of 2 things happens: 1) VIX standard deviation spikes high enough or 2)backwardation is high enough.
This first criteria has had a decent number of occurrences over the backtest period. It has been a fairly reliable indicator that VXX will be moving higher in the near future (often but not always). The second criteria has only happened in the past a few times. It occurred briefly in 2007 but mostly in 2008 and 2011. The 2010 correction, while significant, saw almost no backwardation in the vix futures. The lack of occurrences makes me nervous to include it as a rule. In addition, I believe that volatility has a tendency to decline all else being equal. I think I’d be more comfortable with a cash position during the rare occurrences when backwardation is high and the VIX standard deviation is relatively low.
How would this affect hypothetical performance of the strategy in the past? Eliminating the rule makes very little difference on how the strategy would have performed during the backtest period. It would have resulted in better performance in 2011. The biggest benefit in 2011 would have been less drawdown as VXX would not have been held during the October rally.
It was only a matter of time. TVIX share prices plummeted over 29% today, crushing any who were long. It closed the day at $10.20. Even with today’s crash, the share price is STILL way above NAV of $7.83 per share. The NAV went up today, btw.
For those who don’t know, Credit Suisse halted share creation on TVIX in February, due to internal size limitations. This caused the product to stay artificially high as demand outpaced supply. TVIX stopped working as it was created to once this happened. The exact catalyst for today’s crash is still unkown. It was bound to happen at some point but it’s unclear why today was the day.
Looking at the Twitter/StockTwits stream, it’s clear many don’t understand what’s going on. Hell, even on a good day people are very clueless of the various volatility products. I can’t be too harsh on those new to them. I made my own mistakes last summer (documented on this website).
What I can say is that most retail investors would be better off ignoring the various volatility ETPs. If they really want to play them, I do have some tips from my own experience. They include the following:
1. Due your due diligence!!! These products are complex and require a lot of study time. You need to familiarize yourself with the VIX futures market and how it determines what VXX, TVIX, XIV, et all do. You need to know that these products and the VIX can go in opposite directions on any given day. You need to understand the effects of contango/backwardation over time.
2. Start following intelligent bloggers in the volatility community. This will keep you informed of developments in these products and keep you from going long a product like TVIX when it breaks. Here’s a few I’d reccomend:
3. Study the entire history of VIX futures (from 2004) and study simulated values of VXX/XIV prior to their inception. There is a ton of risk on both the short and long side of the volatility market. Know what you’re getting yourself into.
4. Study the entire history of the VIX (and VXO, it’s parent index). Understand that the VIX can stay in the low teens for years at a time sometimes. Also understand that it can spike violently in a single day without any warning.
No one can know for sure where any of these products will be trading in a month but understanding how they work will put one in a much better position to trade them profitably.
Note: This post refers to the Thrift Savings Plan (TSP). It’s a 401K option for federal/military employees. Options are limited. See this page for more info about the timing strategy I developed.
Last summer the TSP model switched to a 100% G fund allocation. The allocation changed again on January 12th of this year to a very aggressive 100% C fund allocation. So far this has worked out fantastic. The SP 500 has gone up 5.8% since the newest signal occurred.
The model rules state that the strategy will change allocations again when either the SP index rises 10% from the signal on January 12 (we’d need to hit 1,425 on the index) or the index falls 4% below the 200 day moving average (the average is currently about 1,260). As long as another crash like last summer doesn’t happen soon, I believe we will get to the higher target before the lower one.
If 1,425 is hit, the model will change to a conservative 60% G fund/ 40% C fund allocation. This will protect capital should we head significantly lower again.
There are no guarantees here. The market will do what it wants regardless of what anyone thinks it should do. I expect the TSP model to perform well over the long run. Time will tell.
If you pay attention to VIX related products, you know about the share creation halt for TVIX (the supercharged volatility ETN). Everyone in the volatility community is talking about it. I’ve found a couple write-ups to be particularly interesting and worth reading.
First is a paper by Deutsche Bank (hat tip to Volatility Futures and Options):
A second article compares the exposure of exchange traded products to the VIX futures market:
These articles are eye opening to say the least. It will be interesting to see how the existence and exploding popularity of VIX exchange traded products affect the underlying futures market.