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Jay Wolberg
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I'm an independent stock trader specializing in volatility products. I am the founder of Trading Volatility which provides financial data services focusing on volatility derivatives and capital structure arbitrage. My educational background includes a B.S. in Electrical Engineering from the... More
My company:
Trading Volatility
My blog:
Trading Volatility
My book:
Fundamental Concepts and Strategies for Trading Volatility ETPs
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  • A Note On Corrective Distributions For VXUP & VXDN

    (This article originally published on 5/24/2015 on Trading Volatility)

    I've outlined the basic operation of AccuShare's new VXUP and VXDN funds in this post (as they are designed, but not how they'll actually be able to operate). However I did not go into sufficient detail on the topic of Corrective Distributions.

    Before I get into that though, I'll mention that AccuShares has already told us that VXUP and VXDN are intended only for sophisticated professional and institutional investors. If you're not in that category you will likely find the following information less useful since you won't be trading these products.

    Corrective Distributions are used to help keep the funds trading near their NAV (Net Asset Value). In my previous post outlining the Fatal Flaws of VXUP & VXDN, I explained why it will be common for these funds to trade at a premium or discount to NAV. In fact, as of Friday, VXUP is already trading at a 19% premium to NAV while VXDN is trading at a 17% discount to NAV. Recall that if the closing trading prices deviate from their NAV by 10% over three consecutive business days, the Fund will make a Corrective Distribution on the next scheduled Regular Distribution Date or Special Distribution Date (note: this rule goes into effect only after 90 days since the fund's inception has passed).

    Here's what happens during a Corrective Distribution:

    • First, the Regular or Special Distribution takes place (as outlined in my first post on the topic).
    • Next, each remaining share will be resolved into a risk neutral position comprised of an equal number of Up Shares and Down Shares, based on the share NAV.

    The key item here is that the value is based on NAV, not the market trading price. Therefore, holders of a security that trades at a premium to NAV will take a loss equal to the amount of the premium on Distribution Day. Likewise, holders of a security that trades at a discount to NAV will see a gain equal to the amount of the premium.

    A Corrective Distribution trigger should help close the gap to NAV in advance of the next Distribution Day so that no such "easy money" can be made/lost. Even the threat of a Corrective Distribution trigger (trading at >10% NAV on the third day) could bring about swift moves towards NAV for each of the funds as traders move to close out positions while the premium to NAV is still double digit percentages, or rush to get into positions that are trading at a large discount to NAV. This pressure may even be enough to prevent the completion of a Corrective Distribution trigger on the second or third day of a threat, resulting in wild daily price action.

    After a Corrective Distribution Day I expect the funds to immediately diverge from NAV once again. If the VIX futures term structure is sufficiently steep, the funds will face a threat of a Corrective Distribution trigger again for the following month. This will make it important to constantly keep an eye on the market prices versus NAV and factor these potential events into your trading strategy.

    Tags: VXUP, VXDN, VIX
    May 25 12:02 PM | Link | Comment!
  • Why (And Exactly How Much) Your Leveraged ETF Will Underperform

    (This article originally published 3/19/2015 on Trading Volatility)

    Experienced investors know that owning leveraged ETFs (2x and 3x) leads to decay in the value of the funds. The decay can be so strong that even if you get the direction right you may still end up with a loss. In this post I will quantify the decay on leveraged ETFs to illustrate the dangers of holding these funds.

    As a brief bit of background, leveraged ETFs seek to return the 2x or 3x the daily return of the underlying security. Below are some examples:

    NUGT: Returns 3x the daily return of Gold Miners ETF (GDX)

    DUST: Returns -3x (inverse) the daily return of Gold Miners ETF (GDX)

    TNA: Returns 3x the daily return of small cap stocks (IWM)

    TZA: Returns -3x (inverse) the daily return of small cap stocks (IWM)

    UVXY: Returns 2x the daily return of a blend of 1st and 2nd month VIX futures (VXX)

    There is actually a known formula (**fellow math nerds can see the formula at the end of this post) for the return of a leveraged ETF. The critical variables that dictate leveraged ETF performance are:

    1) The return of the underlying index (e.g. GDX, VXX, IWM)

    2) The actual volatility of the underlying index

    3) The amount of leverage (e.g. 1x, 2x, 3x)

    4) The duration of the holding period

    In quantifying the decay of these 2x and 3x ETFs I will start by mapping out #2, which is the actual volatility of the underlying index.

    1) GDX: Actual volatility (HV20) range: 20 - 80

    2) VXX: Actual volatility (HV20) range: 20 - 130

    3) IWM: Actual volatility (HV20) range: 10 - 40

    Using this information we can build tables and graphs to capture the various scenarios for the return of the underlying and compare that to the return of the leveraged ETF. (Note: All scenarios below assume a holding period of 3 months. Holding a fund for less than 3 months will see relatively less decay, while holding longer will experience greater decay.)

    The return of the underlying index is listed in the first column while the various volatility rates are listed in the top row. The intersection of the index performance and its volatility rate gives the return of the leveraged ETF.

    1) NUGT

    For example, if GDX returned 5% over the holding period and had a 20% volatility rate, the return of NUGT would be 12.3%. Another scenario would be a holding period return in GDX of -12.5% and a volatility of 60%. This results in a return of -48.9% in NUGT. Note that cells colored red indicate that the leveraged ETF is underperforming 3x of the underlying index, while green cells are outperforming. It should be clear from the above that under most scenarios except for when actual volatility is low, a 3x fund will underperform.

    The scenarios in graph above can be drawn in graph form for better understanding. The horizontal axis marks the return of the underlying index (GDX, IWM, etc) and the vertical axis marks the return of the leveraged ETF.

    NUGT & TNA:

    Leveraged inverse ETFs (DUST & TZA):


    Because UVXY is only a 2x leveraged fund we a need different chart. However as shown above, the actual volatility of VXX is much higher as well which changes other input ranges.

    The resulting concept is the same however: the higher the actual volatility of the underlying (NYSEARCA:VXX), the more UVXY will underperform.

    Consider someone who expect the market to crash while VIX spikes 80% and VXX spikes 60%. If the underlying volatility of VXX is 80% (which is likely to happen during market crash), UVXY only returns 12.7%. If VXX returned 80% but the actual volatility of VXX is 110% (it saw 120% in fall of 2011), the UVXY return is only -2.3%. Obviously UVXY is a very poor hedge to hold for any significant duration. It is really only beneficial for short duration trades if you have impeccable timing.

    Here are the UVXY returns in graphical format:

    Don't be lured by the potential return of these leveraged ETF products. Unless actual volatility of the underlying index is very low, you're likely to be just another victim of leveraged ETF decay.


    ** Return (NYSE:R) for a leveraged ETF is defined by:

    Where x is the leverage ratio, σ is the volatility of the index, and T is the time period the investment is held (source Cheng and Madhavan (2009) and Wang (2009))

    Mar 19 1:28 PM | Link | Comment!
  • Utilizing Two Complementary Strategies To Trade VXX & XIV

    (This article was originally published on Trading Volatility on 1/22/2015.)

    In early December we made a second strategy for trading VXX and XIV available to our subscribers: the Volatility Risk Premium (NYSEARCA:VRP) strategy. You may remember me outlining the excellent performance of this strategy in my previous blog post, Volatility Strategies - Separating Fact From Fiction. I liked the strategy so much I decided to make a few adjustments and launch our own version of VRP to use along with our VXX Bias on our Daily Forecast page.

    Why use two strategies for trading volatility ETPs? Because no single strategy is perfect and the market is inherently unpredictable. Using two complementary strategies simultaneously compensates for inherent weaknesses within each of the strategies, reduces drawdowns, and smooths out returns over months and years.

    The VXX Bias and VRP strategies each take a very different approach for maximizing gains. The VXX Bias strategy is based on the term structure and momentum of VIX futures, while VRP is based on the price of VIX and historical volatility measurements. However, each of these strategies thrive and struggle depending on the specific market conditions. For example, the VXX Bias strategy has an advantage in handling periods of moderate drawdowns and sustained periods of backwardation. Meanwhile, the VRP strategy tends to be better with choppy markets and periods of gradually increasing volatility when VIX futures are in contango.

    You can see in the backtest results below that neither strategy consistently outperforms the other over a given year, although both VXX Bias and VRP are vastly superior to a buy-and-hold approach with XIV.

    As you can see in the chart above, using the VRP and VXX Bias strategies together (the green columns) provide more consistent returns than using just one strategy alone. In most years the "VRP + VXX Bias" strategy return falls roughly halfway between the VXX Bias and VRP strategies used on their own. (Note: There are a couple ways to incorporate two strategies, but the easiest way is to trade in VXX or XIV only when they agree on the trade direction, which is how the above results are generated.)

    Looking at the strategy statistics below, we see that the VRP + VXX Bias strategy benefits from a reduced maximum drawdown and a 1.14 Sharpe Ratio.

    Some other relevant stats for trading only when VRP and VXX Bias agree on direction (years 2004-2014):

    - # of trades: 128

    - Avg hold time: 10.76 days

    - # of days out of market in cash: 678 (out of 2711) --> 25%

    - Avg gain: 5.69%

    - Max gain: 216.2%

    - Max loss: -20.6%

    The equity curve for each of the strategies (below) illustrates the smaller drawdowns and improved performance of using VRP and VXX Bias together:

    Table of annual returns for the above data:

    Full test data for both the VRP and VXX Bias strategies can be found in the spreadsheets at the bottom of the Subscribe page. You can also read more about our trading strategy on our Strategy page.

    Access to our daily indicators and automated alerts for both the VRP and VXX Bias strategies is available via subscription to Trading Volatility+.

    Hypothetical and Simulated Performance Disclaimer

    The results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown.

    Tags: XIV, VXX, uvxy, SVXY
    Jan 22 5:42 PM | Link | 5 Comments
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