Dear Traders and investors,
I´m happy to give a 12 months update on my conservative short volatility strategy which went through the february crash without a dent.
Volatility situation during the strategy´s lifetime:
From April 2017 until end of January 2018 stock markets remained in a calm and solid uptrend. Therefore volatility and volatility of volatility remained low.
This was the most optimal environment for inverse short term ETPs like XIV and SVXY and resulted in an exponential upmove of those.
However, like any experienced trader would anticipate this phase had come to an end. At the beginning of February 2018 stocks experienced a swift crash which led to a volatility explosion of unseen magnitude.
It was the strongest VIX single day upmove in history and it annihilated any short volatility ETN/ETF.
Anyone trading inverse volatility products who didn´t understand their inner workings got wiped out during a -91% drop in XIV/SVXY in just 3 trading days of which 84% occured overnight.
In the following days, XIV got terminated and delisted according to the prospectus´ guidance.
After this event, which was a financial catastrophy to many, short volatility exposure of SVXY got reduced from 100% to 50% and long volatility exposure of UVXY got reduced from 200% to 150%.
These changes were supposedly made to protect investors in the future. Of course it is stupid to try to protect investors after the fact but these changes in vola ETFs effectively reduced the recovery ability for IRA accounts…
The strategy´s performance and reasons:
As you can see, my strategy didn´t experience any significant loss during its lifetime albeit the horrific conditions we experienced. In fact it managed to pick up some of the mean reversion of volatility right at the bottom in February and
paused trading just before we had the second market drop. This result comes from 100% mechanical trading based on backtesting with robustness and low risk as prime targets.
Why did the strategy underperform the S&P500?
My strategy has 3 key aspects on which it is build:
- it only goes short volatility and uses stoploss because in the long run this is a winning strategy if you protect the downside (just like going long the S&P500 but better)
- it slowly and carefully builds up position size if volatility rises because the longer a high vol event endures the more likely it is to reverse and the more potential it has
- it completely stops trading if volatility is too low for too long time - or reverses too quickly. Backtest tells that under these conditions it is unprofitable to stay short vol over the long run.
If you think about it, risk actually increases when volatility is very low because at some point it will rise again and it usually rises quickly - just like we have seen on 05/02.
As stated above, the market moved up with almost no interruption for most of the lifetime of the strategy. Therefore it was flat for almost 5 months in total. Also we had no major volatility spike to build up a position until the meltdown in February.
Under these unusual conditions the strategy can not outperform the market. However, things are changing. Next week will be the first week where the strategy takes an impactful position and it will finally outperform the benchmark during the next weeks.
On a sidenote, the risk adjusted return is already better than the S&P´s…
IMPORTANT NOTE FOR IRA ACCOUNTS
Since XIV got terminated and SVXY can not be traded in an IRA account at Interactive Brokers, this strategy is no longer suitable for IRA. Thanks @_J for pointing that out and messaging me.
If you are interested in subscribing and still have some questions, don´t hesitate to contact me or post in this topic. I´ll be happy to assist you.
All the best and stay safe,
Alexander
I have no access to IRA anyways because in Germany we don´t have those.
