Robert Zingale

Robert Zingale
Contributor since: 2008
There are a lot of articles out there on this topic (many of them incorrect), which are for more general audiences.
I thought this article did a great job settling the debate on this topic, although there was never a debate in my mind.
If you construct VXX yourself from the VIX future data, it becomes quite apparent that the long-term driver is the difference between F1 and F2.
Ultimately, we might be arguing semantics, but I think the more accurate term to describe what is happening is called "roll costs."
The simulation chose the 5-yr periods without replacement. I was thinking of the returns from a go-forward perspective, but I could've adjusted for inflation.
Thanks for reading.
Completely agree. This strategy should be 5% or less allocation to a portfolio. Risk of ruin is real, but VXZ wouldn't protect you much during that event, as I would expect the VIX term structure to be extremely backwardated during a 1987-style crash. If you are concerned about drawdown, you can always set a stop loss.
Yes, regularly saving at any time interval is by default a form of dollar-cost averaging. However, there is a perception among investors that the more frequent you dollar-cost average, the better it works.
Therefore, for most typical investors saving each year, the real decision is to save sooner in the year vs. monthly dollar-cost average in your retirement account (401k, Roth IRA, IRA).
Although the outcome from this article is obvious to you, many individuals wouldn't have realized how many fewer days your savings will actually be invested if you dollar-cost average over the year.
By DCA-ing annually vs. monthly, one does not presume they can time the market. Both contributions would be agnostic of market conditions, but invest when you have available money.
Also, if you don't think equity markets are going to go up over time (negative return expectations), then why would you invest in equities?
Very well said.
I think the issue that arose while writing this article is that I've been in a situation where I am capable of frontloading my 401(k) without hurting my match. I hadn't realized how less common this is without hurting the employer match.
This article is more relevant for individuals saving in a Roth IRA or IRA.
I agree with you that the difference is dollar-cost averaging annually vs. monthly. However, many would argue that dollar-cost averaging monthly is better vs. beginning of year annually (which is why I wrote this article).
For many people, this might be a good-to-know but doesn't really matter for me because I can't contribute everything at the beginning of the year.
However, if it makes sense for you to save at the beginning of year in a 401(k), Roth IRA, IRA etc., then you should go ahead and do so because monthly dollar-cost averaging doesn't really matter in the long-run.
The order of importance for savers are as follows:
1) Max out employer match (however their plan requires you to achieve this)
2) IF POSSIBLE, contribute earlier vs. later
Erik - the point of this article is actually that you can't beat market returns. Which is why you shouldn't care about the timing of your contributions and invest it into the market as soon as you are able each year.
Therefore, if you are investing over a long-term horizon, you shouldn't be overly worried about market volatility, which monthly dollar-cost averaging is meant to mitigate.
There are companies that do not cap the individual contribution limit of each paycheck.
If your company's plan does not work for this strategy and you'd miss your employer's matching contribution, then don't do this.
Also, this article is applicable to more than just a 401(k). This would also be true for Roth IRAs and IRAs. In these vehicles, you can directly control the timing of your contributions.
The main take-away of this article is that for passive investors, investing your money each year sooner vs. later is better as the stock market has a positive expected return.
I understand many individuals can't invest $17.5k all up front. However, many savers don't max out their 401(k) each year.
Therefore, if they are able to defer 100% of their paycheck in January to reach their $5,000 savings target for 2013 (for example), then this article is still applicable to them.
Because assuming a positive expected return, you will have more days invested and therefore a higher expected return. For example, investing $10,000 in 1972 will yield a higher ending value than waiting until 2012 to invest $10,000. The same occurs by investing in January vs. October but on a shorter scale.
Overall, it is better to invest earlier even if you are unable to invest all in January. Saving everything in Jan, Feb and Mar would still be better than saving over the course of the entire year.
Max drawdown is a measure from peak to trough. Therefore, Blix is correct that this strategy is much riskier than you are implying.
When I wrote an article about a similar strategy back in 2009, I was contacted by hedge fund performing this. They said the biggest problem that you run into is the shares are really difficult and expensive to borrow. I don't think they are still doing the strategy anymore either.
I guess I'm responding to "This risk is minimal at this point in time". This seems very subjective.
I would agree with your strategy if you led with the cap and didn't suggest that a uncapped strategy is prudent.
Also, I'm not sure how your losses are only limited to 15% when VXX went up 343% in Fall 2008. You are long one call and short two calls, so the one call has unlimited risk.
This strategy will get slaughtered during epic rises in VXX, which occur more frequently than you think (%s represent trough to peak over the same period of trading days in which you are selling these calls):
* Summer 2006 (61%)
* Spring 2007 (40%)
* Summer 2007 (98%)
* Winter 2007 (46%)
* Fall 2008 (343%)
* Summer 2010 (86%)
* Spring 2011 (36%)
* Fall 2011 (182%)
Selling VXX calls before the Fiscal Cliff seems like risk seeking behavior.
This strategy wouldn't trigger the day trading rules because the n-count of trades are lower. If you'd like to see how I manage longer term positions in volatility, check out this article.
I started using this technique beginning in 2012 when I got burned from backwardation during the craziness of August and September 2011.
This strategy has thus far turned out successfully. Based on the current rolling costs of VIX futures, there is even a "slimmer chance" than before that VXX will fall below $11 by June. I say "slimmer chance" in quotes because I thought there was a 0% chance of this happening when I wrote this article. I had to make unrealistic modeling assumptions to just get VXX slightly below $11.
IVOP is an inverse ETN to VXX. However, it does not attempt to capture the daily price movements, but the change from an initial price.
When IVOP was priced at $20 during their offering, VXX was worth ~$41. As VXX declines from $42, the % decline is applied in a positive way to IVOP. So today VXX closed at $18.45, making the NAV of IVOP worth:
1) ($18.45 / $41) - 1 = -55%
2) (1 + 55%) * 20 = $31
IVOP's NAV will change less than VXX movements when it is above $20 and change more than VXX movements when it is below $20. IVOP also has an automatic redemption clause at $10. Therefore, I only typically hold IVOP if it is in the high 20s or more.
I like to have a position in IVOP as well as VXX. Because over the long-run, the rolling costs of VXX will likely keep IVOP going higher but IVOP has much less variance than VXX when it is in the high 20s. Also, holding IVOP doesn't pose a threat to ever getting margin called either like a short VXX position would.
Yep not all. Intraday trades aren't really affected by contango or roll yield.
Yes sorry if I was not clear. What RVijay007 said is accurate.
Gotcha. I think we are operating under the same mind set.
I'll keep an eye out for future articles on your site. It was great hearing from you.
Hey you've got a really great blog! I've ran across your site before. There are not a whole lot of people out there that really understand the mechanics behind VXX and VIX futures.
My long-term positions are primarily dictated by the rolling costs of the futures. I am the type of investor that likes to be earning a yield vs. play the VIX future price changes in relation to its mean reverting level. I find that if you follow the roll costs, then they are also decent predictors of future price changes as well.
I'm assuming that your decision to close the shorts was in response to the VIX futures' relation to their historical mean-reverting level. I would agree that price risk is elevated, but rolling costs are still attractive for a short position.
The following article does a decent job explaining my views on profiting from rolling costs:
Great thanks for the advice. I will reach out to them and see what happens.
My 34 day trading period also has the constraint that VIX futures are at or below their current level. Otherwise you could point to December 8, 2011 when VXX dropped ~40% during that time. But the VIX futures started above 30. When you say VXX, you are really saying VIX futures.
I can illustrate this through an fictitious example for clarity. I say Future Y has not historically fallen below 15. Future Y is currently at 16. Therefore, I say it is unlikely to experience of decline of more than 1. Then you say well when Future Y started at 25, it fell 10.
My point is that I realize it has fallen by the amount you state, but it is not comparing the same thing.
I completely agree. Do you know where I could find comprehensive data on this and I will run the analysis?
I believe this is a comment to my other article
When I said VIX short-term index I referring to the futures index or VXX. I did not want to say VXX explicitly because it did not exist prior to 2009, so to be exact I was referencing the index which VXX derives its value from. Probably should have wrote "future" in there for clarity. Thanks for catching :)
The current level of futures has a lot to do with the level of VXX on 12/20/10 because it is more representative of what declines can be seen given the current level of futures. For instance, if VIX futures were are 50 (current month) and 60 (next month), then we know that the price decline that could occur is very large in a short amount of time. Future prices and VXX could theoretically fall >70% in the matter of a day.
However, since VIX futures have had recent trouble falling below 15.55, if you start at VIX future prices of 18, then you will have much difficulty seeing drastic declines. So my analysis looked at what were the biggest declines in the past when starting at the current level of VIX future prices (current and next month prices). What I found was that much of the declines were from rolling costs, but the rolling costs were in an extremely high period (much higher than the current level).
Therefore, I concluded that it was unlikely for VXX to fall below $11 by June 15, 2012.
I think of contango and rolling costs as two separate mechanisms of return. Theoretically, the current month future price and the next month future price could both be the same price (let's say 20). If the VIX index is at 15, and both the current month future and next month future converges to 15 tomorrow, all of this gain is from convergence not rolling costs.
Obviously this is a very stylized example for illustrative purposes, but that I how I think about returns from VXX.
I would write puts on VXX vs. $VIX because I think the intrinsic value of the puts is more mispriced on VXX. I don't think market makers model the decay from contango and potential price declines correctly.
See my article which talks about this
I wouldn't trade this because it is only 8%. When I mention contango, I only mean the delta between the current month future contract and the spot price of the VIX. In this article I was looking for short swings in VXX to profit on.
However, I am short VXX right now (as a longer view short vs. short-term swing trade) because rolling costs are very high. Profits can be made off of the rolling costs as well as the contango, but sometimes the lines get skewed in terms of what actually made you money from VXX. This article was meant to focus on contango/backwardation only. I wrote another article, which explains the powerful gains from rolling costs -
I plan to write another in the near future that puts all of this together (contango/backwardation, rolling costs, slope of term structure, etc.).
Which is the exact situation that I am in. Short a bunch of VXX and long IVOP.
I agree 6 cents is a thin profit but my broker does not make me put up a whole lot of margin for this trade. If successful, I am looking at ~5% return on my margin after commissions in less than 40 days. I think that is a decent bet to make given the rationale I made in the article.
No I believe it very possible for VXX to reach $12 by June 15, 2012. The difference in the probability of reaching $12 vs. $11 is extremely different. VXX is very different than VIX because of the roll costs VIX futures have in contango.
My model does consider the loss from roll costs. However, roll costs are only realized through declines in VIX future prices which often occur around expiration. Additionally, my worst case scenario analysis assumed that roll costs (next month future price / current month future price minus one) were 16.6% on average (vs. the current level of 11.6% as of my writing) and that the current month future and next month future price both converged to 15.55 on the day of option expiration. Usually this convergence would not occur until future expiration which happens the following week in June.