VXX is iPath's short-term VIX futures ETN, which maintains a constant one-month weighted average maturity by rolling one- and two-month VIX futures. The VIX futures derive their price from the VIX Index, which is calculated from the implied volatility of near month options trading on the S&P 500 index. Implied volatility of these options has historically shown a mean-reverting level and therefore, the VIX index does as well. The long-term mean of the VIX has been around 21, as shown in the graph below.
This has implications for the trading ranges of VIX futures as well. Large deviations from the mean-reverting level will be less likely to persist.
I've also observed (as shown in the charts below) that large upward and downward price changes at the opening price are less likely to continue in the same direction for the rest of the trading day. I believe this is caused by an overreaction (enthusiasm or fear) by market participants at opening but a later realization that VIX futures have mean-reverting characteristics.
I've analyzed a trading strategy (data since 1/30/2009) that shorts VXX at open when VXX opens higher and buys VXX at open when it opens lower. All returns are shown before trading costs.
- Initial position - short VXX when open price is X% or greater than previous day closing price
- Exit trade - cover short once it hits a price Y% lower than open. Cover short at close if target price is not hit
The following chart shows the average return per trade when shorting VXX when opening X% or greater and covering once it falls below Y% from the open price:
As shown in the chart above, volatility is more likely to fall after significantly rising at open. Shorting VXX when it has risen by 8% or more at open over the previous close results in the most successful trades on average.
Due to the low average return per trade and low prevalence of VXX opening this high, trading VXX under this strategy would not leave much return after trading costs. The total return before trading costs would only be 7% under the best scenario. However, buying VXX after volatility drops produces better returns as shown below.
- Initial position - buy VXX when open price is X% or lower than previous day closing price
- Exit trade - sell once it hits a price Y% higher than open. Sell at close if target price is not hit
The following chart shows the average return per trade when buying VXX when opening X% or lower and selling once it rises above Y% from the open price:
As shown in the chart above, volatility is more likely to rise after significantly falling at open. Buying VXX when it has fallen by 4% or more & 5% or more at open over the previous close results in the most successful trades on average.
Based on these results, a good trading strategy would be to buy VXX when it has fallen by 4% or more at open over the previous close and sell VXX once it has risen 5% over open price or at closing price if target price is not reached. This would return an average return per trade of 1.3%. I recommend this trade even though other strategies produced a higher average return per trade because this strategy also occurs more frequently. The total return over the time period analyzed was 36%.
Disclaimer: Please consult your financial advisor before making investment decisions. Depending on your circumstances and risk tolerance, the strategy in this article may not be suitable for all investors.