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Shorting Vol? Seek Survival, Not Profits

Given my relatively small account size, I have decided to postpone my Tactical Allocation Portfolio. Instead I will focus on the far riskier aspect of the TAP, shorting volatility. Once I am satisfied with my account size and its expected "long term" returns, I will probably run the TAP along side this short vol trade.

So back to the point of this post. I did data mining and I created a few charts I thought were interesting. VXX has only been available since 2009, but thanks to some very smart people the theoretical VXX data is available back to 2004. Google is and you will easily find it. This is great as it gives us a look into what happened during the 2008 crisis. If one looks at a short VXX position as equivilent to that of selling insurance, the results were as expected. The scale though, I was a bit surprised with.

First, in terms of profit. Does shorting VXX at elevated VIX levels deliver a faster rate of VXX decay? As you can see over 30 and 60 day periods, the answer is not really.

The returns below are from the prospective of being short.

I chose such seemingly short time periods because over the long term, whether you short VXX at 200 or 100, your return will be about the same.

So it seems the decay isn't noticibly faster at higher VIX levels, but what about drawdowns? This is where the the data shows strong correlation.

Its clear to see the largest drawdowns occur from the lowest VIX levels and gradualy decrease as the VIX moved higher. So while it is true, over the long term, that shorting at a VIX of 10 will give you nearly as much profit as someone who shorts at 40. The problem is, shorting at 10 with any substancial size, could blow up your account. Being in the game is extremely profitable, if you can just manage the risks.

The plan is to have my positions be "forever shorts" in that I will never cover, so the potential drawdowns are a very real thing for me, which is why I must remain small until the proper situation presents itself. I will scale in in amounts that slowly grow as the VIX rises in order to avoid the largest drawdowns on my largest entries.

Disclosure: I am/we are short VXX.