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Two-for-One Punch: Benefiting from Volatility Mean Reversion and Contango

[Please read important Disclosure below]

Volatility is mean reverting (See VIX Index chart below and reference academic research on the subject).  Hence, statistical arbitrage can be employed to seek out return opportunities involving volatility.  With recent spikes in the VIX Index one could consider some volatility strategies depending on preferences and conviction.  Two such strategies could be short Vega strategies employing options or employing Exchange Traded Products (ETP).  I will focus on the latter given its more intuitive and added embedded tailwind.



A strategy employing ETPs could be employed to express a 'view' on volatility.  If one believes volatility (for this discussion read VIX Index) will increase, consider long oriented ETPs that gain when the VIX Index or derivatives increase in value.  If one believes volatility will decrease, consider shorting long oriented ETPs or alternatively go long an inverse oriented ETP (E.g. Ticker "XIV").  Note that there are nuances to be understood about these investments which can be found in respective prospectus and disclosure documents for respective ETPs - I would urge you to study this material carefully before investing.  Bottom line is; know what you own!

To express the above view on volatility is considered a directional trade.  One either believes that VIX will go up or down and will position for accordingly.  There is another reason to contemplate some of these ETP strategies.  There is an added tailwind which has to do with what these ETP own inside of them and the characteristics of the underlying futures curve of volatility (VIX Index in this case).  The upwards sloping futures curve can be described as being in contango.  As such, by being short (read inverse) one can benefit from the roll yield.  The chart below illustrates the shape of the futures curve for the VIX Index and the associated negative roll yields from month-to-month.

 

This combination of having a view and benefiting from the current contango offers a two-for-one punch in terms of the statistical arbitrage opportunity as well as benefiting from the roll yield opportunity.

Please look for an upcoming white paper on Volatility as an asset class.  To receive more information please visit www.pointguardcapital.com and please submit your e-mail to receive notice of when the website is launched.

Disclosure:
As of this writing I am long "XIV" with a short-term time horizon to exploit what I believe is a statistical arbitrage opportunity as well as an event driven opportunity as presented by the recent debt ceiling debate.  I believe that resolution of the debt ceiling debate will lead to lower VIX Index levels and want to benefit from the negative roll yield due to contango.  I opted to employ an inverse ETP to express these views with a moderate degree of conviction.

This piece is meant for informational and educational purposes only.  The above strategy is not for the faint of heart as there is volatility in volatility.  This is not a solicitation for or a recommendation to buy, sell or hold any security.  Please consult with a professional and review any disclosure and prospectus material before investing.