"Do you scurry like a rat, or soar like an eagle? Stop imitating the crowd and try new ways of doing things." - Malcolm Out Loud
What prompted me to the analysis set out below was reading yet another piece about what, "evil-doers," the volatility ETFs had become. VXX, XIV, UVXY and TVIX have been pretty much raked over the coals; on the mild side by descriptions of them as an inefficient way to trade volatility to the more insidious extreme of calling the whole sector a suckers bet. Wherever commentators have been on the continuum of dislike for these trading vehicles, one thing stood out; they were being universally shunned as effective proxies for trading the ups and downs of market indexes.
My claustrophobia for crowds had me thinking that the exact opposite is true, that VXX is better at trading indexes than the indexes themselves. Sounds like an hypothesis to me.
Looking at the past 12 months of market swings as measured by simple linear trend regression channels, I found six intermediate term trends, three up and three down. When the SPX trend was higher, I measured its percentage gain against that of XIV, the inverse fund for VXX. When SPX was trending lower, I measured its percentage loss against the percentage gain of VXX. In other words, I was LONG XIV for market uptrends and LONG VXX for market downtrends.
Below are my findings, as set out in a series of dual-chart images. On the left of each image is a chart of SPX, its linear trend regression channel for the one of its six intermediate swings, and the net gain or loss for the move. I used closing prices on the first bar of the indicated trend and the last bar of the trend for all computations.
On the right side of each image is a chart of either XIV or VXX. I used XIV if the corresponding SPX move was up and I used VXX when the corresponding SPX down. Again, all XIV/VXX prices are from the closing prices of the beginning and ending bars of the linear trend regression channels.
Here is a summary of the results of the six indicated trends above:
Downtrend: July 7, 2011 - Oct 4, 2011: SPX = -17%; VXX = +163%
Uptrend: Oct 4, 2011 - Oct 27, 2011: SPX = +14%; XIV = +35%
Downtrend: Oct 27, 2011 - Nov 28, 2011: SPX = -10%; VXX = +27%
Uptrend: Nov 28, 2011 - Apr 2, 2012: SPX = +19%; XIV = +140%
Downtrend: Apr 2, 2012 - June 4, 2012: SPX = -10%; VXX = +30%
Uptrend: June 4, 2012 - Aug 31, 2012: SPX = +10%; XIV = +75%
For at least the past 12 months, using XIV to trade uptrends in SPX and VXX to trade downtrends has provided excellent trade returns that are significantly higher than trading the indexes.
(1) Correctly identifying whether SPX is in an uptrend or downtrend is much easier in retrospect than in real time. But if you have a reliable way to identify such trends, trading XIV/VXX as proxies is a very effective methodology to maximize returns;
(2) The data set is only six identifiable intermediate trends in about 12 months, which opens the door that the conclusion is based on a limited database and could be an anomaly; i.e. it will not hold up going forward;
(3) That these volatility ETFs are unstable and cannot be relied upon for any trading regimen. Supporting this view is that there is no consistency in the outperformance of XIV/VXX over the index. While that is true, does it invalidate the entire hypothesis? Some trends are better than others, always has been, always will be.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in XIV, VXX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I trade the market by identifying intermediate term trends and should a trend be identified in the next two trading days, I will go long XIV or long VXX, depending on the direction of that trend.