As 2017 comes to a close, I genuinely want to thank all of you for the support this year. I received more questions and had more great conversations with people than ever before and I truly appreciate it. Hopefully you all had a great experience and learned a little something from my work. I’ll keep it up if you keep watching, and feel free to always ask me anything that’s on your mind. Let’s make 2018 even better! Thank you.
This is Volatility Trading Strategies so it’s fitting to close out the year with a final update on the record setting low volatility environment we saw in 2017. As you know I don’t like to make forward predictions as they are irrelevant to my systematic decision making process, but I suspect we won’t see another year like this one in quite some time, and perhaps never again. By any and all metrics it was the lowest volatility on record.
Annual VIX index mean values every year since 1990:
I’ve periodically discussed this year that the historical data shows that low volatility environments are not ideal for volatility product performance. While volatility is not immediately and predictably mean reverting, on a longer time horizon it very much is mean reverting. So when volatility gets very low, probabilistically speaking the risk reward profile for holding products like the XIV gets less and less attractive.
XIV performance when the VIX index is in it’s low range:
Now “low” is a little subjective, but forgive me for not wanting to give away one of my secret indicators… As you can see, holding XIV during low volatility worked out very well in 2017 because volatility went low and stayed there pretty much the entire year.
But on a longer term scale that would still to this day be a losing strategy. Still not back to break even. And if you look back at the annual mean chart, volatility really only stays this low once every 7 or 8 years on average. I’m not the type of investor that likes to do things that only works one year in seven.
All of my indicators are dynamic so this low volatility we’ve seen this year will definitely be factored into future trading decisions as it is now part of the extended data set. But quant based trading requires a strict adherence to the data, not front running predictions of what might be. We only trade what is.
Taking chances that go against historical data and doing things that only work sometimes is the reason the average investor (and fund manager) struggles to beat the S&P 500 in the long run. I’d rather respect historical data and take what the markets give us.
But I for one do hope 2018 brings a little bit more volatility. 2017 was impressive to watch unfold, but it’s definitely not the norm and I would imagine we’ll see at least a few minor periods of elevated volatility going forward.
All VIX index closes under 10 since 1990:
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