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I am an individual investor currently swing trading volatility ETNs (XIV and VXX). I am developing strategies for timing trades and backtesting using excel. Contango is my friend. My handle on twitter is @ContangoMojo
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  • Update To The Volatility Trading Strategy Using Chandelier Stops

    Back at the end of January I presented an article to show a good XIV trading strategy using chandelier stops as a signal to go long XIV and when to get out.

    As I mentioned in the first article, I do not strictly trade this strategy but I do use stop loss orders for my XIV trades and I tend to only go long when this strategy says to go long.

    Since publishing the article, the strategy has had very mixed results with several months of choppy trade and one month of spectacular results that made up for the previous trades.

    • The VIX spike in February stopped out the trade causing an 8% drawdown.
    • The strategy gave a buy signal in early March and made a nice 19.8% run. The VIX spike in April stopped out the trade causing a 9% drawdown.
    • The strategy gave another buy signal in late April and made a very short 4.5% run. The VIX spike in early June stopped out the trade causing an 9% drawdown.
    • Overall, in this choppy sideways period, the strategy lost 4.3% from end of January to end of June.
    • On July 1, the strategy gave it's latest buy signal and gained an impressive 41.7% before settling down and giving the latest sell signal; settling for a nice 32.4% gain.

    Here is an updated chart showing the chandelier stops on XIV along with the equity curve for the strategy.

    (click to enlarge)

    It seems like the strategy can be improved by using tighter stops to lock in more profits. And I am sure we could add indicators or other macro news filters that would keep us out of the trade completely in certain markets like the April to June taper talk market.

    Still, overall, the strategy as presented would have gained 448% in the last 2.75 years; or 13.6% average per month. Again this is not any guarantee of future results and is not statistically significant enough to bet on. We certainly could have an extended period of up and down swings like we had for 5 months this year.

    Please do leave comments below if you have any feedback on this article or the strategy.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: I am currently in cash but will go long XIV when we get the next buy signal.

    Tags: XIV, SVXY, VXX, Volatility, ETFs
    Aug 29 1:03 AM | Link | 5 Comments
  • Daily Volatility Trading Strategy Using Chandelier Stops On XIV

    Over the last two years I have become a student of trading volatility strategies. See my last Instablog article for a useful index of articles that deal with volatility trading strategies.

    Volatility ETPs like (NYSEARCA:VXX) and (NASDAQ:XIV) are great products for momentum swing trading because:

    • They tend to move in waves. These ETPs follow the volatility futures and those futures move based on waves of investor sentiment of fear and complacency.
    • When the ETPs get going in one direction, they continue with a lot of momentum in that direction for many days.
    • They make huge moves. As long as you are betting in the right direction most of the time, you can really make nice gains.
    • Because of the term structure of the futures, these ETPs tend to have a strong bias in one direction (VXX down, XIV up)

    I have developed an aggressive strategy that can be used by any trader who has a full time day job and no time to watch their trades while the market is open. This is also a good strategy for any type of trading account including IRAs and avoids the pattern daytrading rules.

    WARNING: Do not use any XIV strategy unless you completely understand the following statements about XIV. XIV tracks the inverse daily percentage move of the Volatility Futures short term index and is rebalanced daily. XIV has a strong upward bias when the volatility futures term structure is in Contango. XIV can lose 50%-80% of its value in hours or a few days when there is some sort of market shocking event.

    The Strategy

    Average True Range (NYSE:ATR) is a measure of how much a stock or index moves every day. Traders often use ATR to determine where to place trailing stop loss orders. This is also known as a Chandelier Stop. A good description of using chandelier stops is here or here. Using a XIV stop loss is key to limit major losses when there is a major market shock or black swan event.

    Strategy Rules:

    1. Play XIV on the long side only.

    2. Buy XIV if it rises two times the 14-day Average True Range above the recent closing low. Buy at the Open of the next trading day after seeing this signal.

    3. Set a Stop Loss sell order at 2.5 times the 14 day ATR.

    4. Every day, reset the Stop Loss order at 2.5 times the 14 day ATR. Only move the stop up. If XIV had a down day, leave the stop at the same level as the previous day.

    If you have a day job like me, you can set your buy order with your broker in the morning before going to work and you don't have to watch it all day.

    I pull data down from Yahoo Finance into an Excel spreadsheet every evening to recalculate the ATR and to determine where to reset the stop loss sell orders.


    The Chart below shows the XIV price since the ETN's inception as well as the placement of the 2.5 ATR stop loss orders.

    (click to enlarge)

    Note how the strategy tends to go long right at the start of new long term uptrends.

    Once a new uptrend starts, it can go for several days before ending.

    Because of the rising Sell Stops, we get to keep the majority of the swing gains.

    If XIV is moving sideways or down, the Sell Stops move sideways.

    XIV occasionally jumps quickly and the strategy often has us long at these times.

    The strategy had us in cash near the start of the large drop at the beginning of August 2011.

    There are significant whipsaws when we go long too early, during a downtrend, but these are offset by the times when we were correct and got long at the beginning of an extended uptrend.

    Strategy Performance

    The chart below overlays an equity curve on top of the same chart.

    (click to enlarge)

    A portfolio of $10,000 would have become $38,832 since December 2012. That's 388% gains in just under 26 months - an average of 15% per month.

    Notice how some times buying and holding XIV would have performed better than the strategy going to cash during a correction. This is the price we pay for having our Stop Loss orders to protect us from disaster.

    The two worst drawdowns were August-November 2011 where the portfolio lost 50% and March to June 2012 where the portfolio lost 38%. In both cases, the portfolio recovered quickly.

    Trading XIV is not for the faint of heart!

    These results are not statistically significant because of the short time period in play and the small number of trading signals. I can't promise XIV will continue to work this well in the next two years. It is possible to get an extended string of drawdowns if we have shorter waves of fear and complacency in the VIX futures market.

    You could build a similar strategy using short VXX. Since XIV is an inverse fund and it rebalances daily, it loses value due to tracking error when the underlying futures index has choppy up/down action. A VXX Short performs better than XIV most of the time. I choose to use XIV because I don't want to ever be in an unlimited risk position where my broker will be calling to liquidate my short position..

    This strategy only looks at the trend and price action in XIV. There are many other volatility strategies that use the amount of Futures Contango, the S&P 500 trend, or VIX index level for entries and exits. You can improve on this strategy if you layer in additional information before buying.

    I do not follow this strategy mechanically myself. I use a measure of contango and other indicators in addition to XIV price action to determine my entries and exits. I do, however, always make sure to have a sell stop in place when I am long XIV.

    Disclosure: I am long XIV. 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.

    Jan 27 7:35 AM | Link | 4 Comments
  • Anthology Of Writings Essential To Volatility Traders

    Over the last year and a half I have followed several great bloggers and read some research papers that have given us great insight into trading volatility as an asset class on the long side and the short side.

    With this, my first Seeking Alpha article, I am indexing and reviewing the "must read" materials on the internet that every serious volatility trader should study and understand. Particularly if you are an individual trader or a retail investor trying to profit from ETNs like VXX, TVIX, XIV, UVXY or SVXY; you need to really educate yourself before you risk a lot of money.

    So, consider this blog post as the Anthology of writings essential to volatility traders.

    The articles below form the basis of my VIX education from volatility mentors who allowed me to double my IRA account in the last year with some long term swing trades.

    Be forewarned, some of these articles are very heavy in math that I do not fully understand but you should read them with a view of getting the conclusions.

    The VIX is a statistic, not an asset

    Even though financial talking heads talk about buying the "VIX", it is not possible to buy it. VIX is a statistic that measures the implied volatility of a basket of SPX options contracts. When SPX options get more expensive, the VIX index goes higher. I urge any newcomer to trading the VIX to spend several hours reading as much as you can from Bill Luby's incredible VIX and More blog. These four articles are a starting point.

    VIX Futures are the underlying assets that make up the ETFs

    José Raúl Vasquez explains how to calculate the VXX price based on VIX Futures.

    Adam Warner writes that there is no significance of a VIX ETN having a certain value (such as a new 52 week low). "Price points in VIX derivatives have no value, though. They are driven almost entirely by math. There's no VIX value that correlates to any specific value in VXX, or any other VIX derivative. They have value as trading vehicles in that if you time a VIX move well, but use VXX, you will likely win in the short term. But they don't have value in terms of their absolute price."!+/outsidethebox_blog.aspx?single=true&blogid=111957

    Futures and Options traders are betting where VIX will end up, but these bets are highly skewed by a future risk premium

    VIX futures represent the market's expectation of where VIX will be x days in the future; however, this does not necessarily give an accurate prediction of where VIX will be in those x days if x is more than 30 days. Rather, the longer term futures always have a risk premium built in that reflects market sentiment (fear of the future). In this paper, Nossman and Wilhemson prove that this risk premium does exist, can be measured, and mutes the ability of the longer futures to predict where the VIX will end up. This paper also concludes that short term VIX futures (1-30 days) do reasonably predict where the VIX will be in that short term scenario.

    Will the billion dollars bet on VIX ETNs and Futures affect the actual stock market? Vance Harwood explains how VIX futures are hedged by market makers and should have a neutral effect on the S&P500.

    The effects of futures term structure: contango and backwardation

    Steven Lee of the Third Eye Market Analyst Blog writes that the average daily cost from contango has been 0.25% for each day and the cost can rise to 0.45% as the futures near expiration.

    Bill Luby explains why VXX is not a good short term holding and not a good long term holding.

    José Raúl Vasquez writes that VXX would have lost most of its value had it existed in 2004. Even the 2008 financial crisis would not have brought VXX back to the original level. Note the excellent chart depicting this.

    Robert Zingale explains what happens to the VIX futures as they near expiration when they are trading at a premium to the VIX index. He also describes how much contango or backwardation are ideal for establishing short or long VXX trades.

    Bill Luby shows us what happens to the VIX Futures term structure when contango gives way to backwardation like it did in late July 2011. Note how the near term futures did not increase as much as the VIX index did.

    VIX ETN's are not a great portfolio hedge

    In the series of research papers, Alexander and Korovilas conclude that "ETN market activity has spilled over to the VIX futures market, increasing the volatility of VIX futures so that they have now become some of the most risky of all exchange traded instruments". The large-scale hedging activities of ETN issuers since 2009 have transmitted volatility to the VIX futures and VIX options markets. They also conclude that the VIX ETNs "offer no opportunities for diversification of equity exposure, except during the onset of a major crisis. In short they should only be used for speculative trades".

    Taking the other side, Jim Fink from Investing Daily describes how to a small portfolio allocation to VIX Calls can act as an effective portfolio hedge.

    VIX ETN, Futures, and Options Trading Strategies

    Using a simple ratio of VIX to VXV gives a measure of the term structure of SPX options premiums. It has been an excellent indicator to tell you when it is safe to short volatility. I love the way this indicator works like an oscillator giving you hints about the changing waves of fear and complacency being priced into the options markets. Vance Harwood writes that when the ratio is below 0.9 that's a good time to short volatility.

    VIX futures tend to move in waves or trends. Up days tend to follow up days and down days tend to follow down days. Nat Stewart of NAS Trading backtests a strategy that looks at this trend effect. He also factors in the VIX futures term structure and a simple SPX trend following method to trigger a long or short volatility position.

    Robert Zingale noticed that VIX futures tend to reverse direction intraday when there is a big initial move in the morning. It would be a profitable trading strategy to short VXX after it had opened up significantly or buy VXX after it had opened down significantly. I don't daytrade but this is a great nugget that can help you time your entries and exits even if you are making longer term trades.

    Alexander and Korovilas propose a construction of simple ETN portfolios they name CVIX and CVZ that are made up of XVIX and XVZ. CVZ has a dynamic allocation that swaps the two ETNs depending on contango or backwardation. These strategies offer uncorrelated portfolio diversification and would prove to be a great buy-and-hold method of using volatility.

    Michael Stokes of the MarketSci Blog gives a critique of a strategy using only RSI(2), to time VXX trades. It's a good reminder that any strategies need to be backtested back to before the financial crisis before trusting that it is a solid one.

    Dr. Tom Hogshead of Volatility Research has developed some indicators that will predict the movement of VXX in the short term. One is to trend Runs - the number of days in a row that VXX is up or down. By studying the run trend and watching for the trend change, they predict when VXX will reverse direction. I find this method difficult to understand on the blog but I am trying to calculate it and backtest it myself. While I don't get the same data as they do, I find this method has promise and is a good one to measure the momentum of the VIX short term futures. I am still trying to determine if it's got any predictive abilities.

    In this academic paper, David Simon concludes that "the VIX futures basis does not accurately reflect the mean-reverting properties of the VIX spot index but rather reflects a risk premium that can be harvested." Simon studies a strategy of selling or buying futures based on contango/backwardation and then hedging the position with mini-S&P futures contracts to offset the chance that there is a significant move in the level of the futures.

    Steven Lee of the Third Eye Market Analyst blog gives us a process to forecast VIX and VXX based on whether the VIX is lower or higher than other volatility measurement models such as GARCH and Implied Volatility of S&P 500 index options; and by looking at the historical probability of VIX levels relative to the current S&P 500 trend.

    Robert Zingale gives an interesting strategy of investing in a dynamic allocation of long VXX, short VXX, or Treasuries depending on the level of contango in the first to second month VIX futures.

    In the two following articles, Michael Stokes of the MarketSci Blog describes how to use the contango/backwardation and a 10-day EMA of the VIX index as part of strategy to time VXX or XIV trades.

    It is clearly a winning bet to short volatility after a large spike in volatility (if you get the timing right). Bill Luby of the VIX and More blog discusses options strategies for shorting volatility after a major Volatility spike. Using options you can limit your potential losses and still have a possibility for large gains.

    Kevin O'Brien uses a reverse iron condor options spread strategy on VXX weekly options contracts for weekly profits. Since VXX is a volatile product, the options strategy profits if the ETN moves higher or lower in a few days.


    I hope you enjoyed my collection of favorites. I have some Google alerts in place to find when something new has been posted. I continue to add to my favorites as new compelling articles are published.

    Please leave comments if you have any recommendations of articles that should be included in this collection of essentials. Which articles were your favorites?

    My current interest is in developing indicators and strategies to time VXX and XIV swing trades in my IRA account with a high degree of confidence. Comment or message me if you have suggestions for good indicators you use to time your trades.

    Disclosure: I am long XIV. 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.

    Tags: etf-analysis
    Sep 25 8:02 AM | Link | 16 Comments
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