So, why are volatility ETFs such poor performers, given THIS?

[i960]

"Another way to think about the trade is this: by combining a short position in VXX with a long position in the front-month futures, we are in effect creating a residual exposure in the value of the second month VIX futures contract relative to the first. So this is a strategy in which we are looking to capture volatility carry, not at the front of the curve, but between the first and second month futures maturities. We are, in effect, riding down the belly of volatility curve."

I think I mentioned this in another thread at some point in time but any kind of overlaid short VXX/long VX strategy is really just playing games with VX calendar spreads eventually. Let's say you started today with the following data straight from iPath (http://www.ipathetn.com/US/16/en/details.app?instrumentId=259118):

Index Components(as of 02/21/2018)
Index Components Weightings %

CBOE VIX Future MAR 18 83.75%
CBOE VIX Future APR 18 16.25%

and expirations of:

VX H2018-CF 20180321T0000.00 (Wed)
VX J2018-CF 20180418T0000.00 (Wed)

Ignoring position sizing of the VX lots vs VXX percentages (which may very well be where any money in this arises from), if you start out with short VXX + long VXH18, you're basically long H18 at 16.25% (-83.75 + 100%), short J18 at -16.25% (VXX handles that). As time goes on and VXX becomes 50/50, you're then long H18 at 50% and short J18 at 50%. At 20/80, long H18 at 80%, short J18 at 80%.

I can't see how scaling into a long M1:M2 spread is supposed to magically make money with a curve typically in contango. If you instead went long VXX and short VX H18 you'd scale into a short M1:M2 calendar spread instead. BTW: one of his charts shows VXX-VX, not VX-VXX although I can't tell if that's just coincidence or what he really backtested. Seeing as how the entire thing talks about short VXX the entire time it would seem not to be the case.

I don't understand where the alpha is here.

 

[JackRab]

if you start out with short VXX + long VXH18, you're basically long H18 at 16.25% (-83.75 + 100%), short J18 at -16.25% (VXX handles that).

And normally this is a losing trade... since the contango means the front month VIX future will drop faster than the back month.

This whole strategy is flawed, I think there's some mistakes in calculations which seems to generate that alpha, but I reckon there will be a hidden risk. No way this is a proper arb.

 

[i960]

And normally this is a losing trade... since the contango means the front month VIX future will drop faster than the back month.

This whole strategy is flawed, I think there's some mistakes in calculations which seems to generate that alpha, but I reckon there will be a hidden risk. No way this is a proper arb.

My thoughts exactly. He also glosses over quite a bit of real shit to actually worry about in the pursuit of showing us this "volatility carry strategy", which isn't new, nor is it riding the "belly of the curve" or any of that either.

 

[Saltynuts]

Thanks guys. I figured it was wrong - it essentially has to be since the very thing he is shorting is, on average it seems, almost exactly equal to what he is going long, but with the thing he is going long having a shorter maturity on average, hence more contango on average.

Do yall know if there is a place to get historical VIX future contract prices? Would like do run the math to prove it to myself if possible.

The other thing he talks about is the huge drawdowns. Well, with what he shorting being so close to what he is going long, I would think his drawdowns would be very little. Based on this, didn't he almost certainly short proportionately more than he went long? So he might have short 1.5x worth of principle and went long only 1.0x worth of principle. This would explain both why the strategy was so profitable over time, as well as why there were such large draw-downs.

By the way, out of curiosity, he mentioned that VXX or what not had something happen end of month were VXX would significantly outperform (on the upside) the VIX long futures position. Any idea what he might be referring to ? I just don't get it - I would think every day VXX would be rebalancing, and it would make no difference what day of the month it was.

Thanks!

 

[JackRab]

By the way, out of curiosity, he mentioned that VXX or what not had something happen end of month were VXX would significantly outperform (on the upside) the VIX long futures position. Any idea what he might be referring to ? I just don't get it - I would think every day VXX would be rebalancing, and it would make no difference what day of the month it was.

Thanks!

My guess is that's about the VIX expiration... and he would already be out of his futures, or rolled over to the next month. So it wouldn't affect it, but it does affect the spot and VXX. I think generally on expiration the VIX spot get's pushed up, they manipulate the SPX options prices to do this. That's just my 2 cents, not really examined it thoroughly...