VIX Shorts, Have A Little Patience

Includes: SVXY, VXX, XIV
by: The Sociology of Finance

I just read an article from SA contributor Macro Investor suggesting that now is a good time to buy short VIX futures products such as (NYSEARCA:SVXY) or (NASDAQ:XIV), with a possible return of 10%-30% by the end of August. I don't necessarily disagree with the call and very much respect Macro Investor's opinions in the VIX (NYSEARCA:VXX) space, but I think retail investors are better served if they sit on the sidelines for now.

It all comes down to making sure you have an edge. Fact of the matter is that retail investors have trouble competing with the big boys in the short run, which I arbitrarily define as a holding period of three months or less. Some of the best VIX data is proprietary, as are cutting edge trading systems and execution facilities. I hold out hope that some dude with statistical software and too much free time can crack the VIX code in his basement, goodness knows I've tried. There is something about volatility trading that brings out my inner statistics geek. But generally speaking, I'd rather play a game in which the odds are much more in my favor.

Trade VIX Like a Value Investor

And here's where retail investors can really press their advantage in the short VIX game: stay unleveraged, wait for a sure thing, and hold on in the face of short term volatility. Dipping below 14 today, the VIX is hovering at about the 20th percentile of its historical value distribution:

(Click to enlarge)

Yes, contango is pretty steep, giving XIV and SVXY holders an additional sweetener if the VIX continues to melt downwards. But the problem is that at such low levels, the risk-reward payoff is skewed in the wrong direction. If in the next month or so the VIX is slightly rising, stable, or falling, VIX shorts get a decent return. But every now and then the VIX spikes, leaving the shorts very sore indeed. So at this point VIX shorts are opting for a good probability of decent returns in the short run in exchange for an uncertain possibility of terrible (very negative) returns.

Now if they just hold on, those shorts will eventually be made whole because VIX futures are usually in contango and the VIX is mean-reverting. But I'd rather wait for an opportunity with a good probability of great returns in exchange for that same uncertain possibility of terrible returns. Investors will likely not have to wait too long for such an opportunity to present itself:

XIV Chart
(Click to enlarge)

XIV data by YCharts

So if your job does not depend on your monthly investment performance and you do not have to follow the same restrictive drawdown rules of many professional investors, have a little patience. Let the big boys fight over those nickels and dimes and save your capital for the next VIX spike.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.