VTS Community,

Bitcoin has stolen some of it’s thunder, but Volatility ETP investing has certainly exploded in popularity in the last year or so, and I’m a little bit torn on how I feel about that.

On the one hand, great, fantastic!  I’ve been trading volatility as an investable asset class for over a decade now so it’s about time it started to get some mainstream recognition.  And I will certainly do my best to ensure that we only take the best part of the market and remain safe and profitable.

On the other hand, I do feel that it can be a sign of danger when we see people pile into a trade in exponential numbers.  If it’s for the right reasons then fine.  If people believe in the underlying principles as to why it works then I welcome it.  However if it is simply because the increased number of articles talking about how easy the “short vol” trade is to make money with and people are scared of missing out that’s when it can be a bad thing.

So my daily blog, my YouTube videos, it’s all directed at helping educate the general public on what this trade actually is.  I want you all to see it for the incredible long-term opportunity that it is, not just simply for chasing big gains in the moment.

Short vol is not new.  This trade has been working not only since 2009 and the introduction of volatility ETPs, but way before that back 30+ years and basic arbitrage of the Volatility Risk Premium through options and swaps.  So I’ll keep working in 2018 to put out helpful content, and please keep asking your questions.

 

VTS Tactical Volatility Strategy

I guess the big story on this strategy in 2017 is the lack of a story at all.  It spent most of the year in cash:

The strategy took less than 4% of trades the whole year, which needless to say has not happened before.  But why so much cash?

As anybody who’s been investing for any length of time can attest to, you can’t hedge both sides of a trade.  Mathematically it doesn’t work that way.  Unfortunately it’s not possible to have a profitable strategy that is protected against market moves in both directions.  Decisions have to be made and every strategy needs to be crystal clear on:

 

–  Which market environments it’s going to profit from.
–  Which environments it’s going to skip.
–  Which ones it’s going to add extra protection against.

 

There’s several different ways to measure “volatility” but one of the most common is simply by the VIX index.  Here is the XIV performance divided into quintiles of VIX index readings:

 

It’s no surprise that the 80-100% range  (in turquoise)  has produced negative performance.  That’s when volatility is extremely elevated, the VIX futures are likely in backwardation, and we wouldn’t expect XIV to perform well at all.  In fact that’s when we will be eyeing possible VXX trades.

But something that surprises many people is that the performance in the bottom 20% range  (in blue)  when volatility is very low, that’s also not been profitable.  It was in 2017 but for the 6 years previous it was not, and if these products did exist I would imagine the same would be true going backwards.  Perhaps only 4-5 years in the last 30 would that have been a profitable range.

Now we know that the XIV and products like it can suffer enormous losses in very short periods of time.  The maximum drawdown since the products launch was -74% when the stock market dropped less than 20%, and it had two other huge drawdowns as well so decisions need to be made.

It’s not a direct link because I use many more volatility metrics than just the VIX index, and in fact the VIX plays a very small role in my investing in general, but the VTS Tactical Volatility Strategy:

 

–  Targets the middle range of volatility readings for profit.
–  Skips the low range of volatility readings for safety.
–  Adds extra protection against the highest readings for hedging.

 

That’s how the strategy has been set up since it’s launch, and in the years before 2017 it worked out very well.  The strategy got into the right number of trades, roughly 45% of the market, and performance was exactly where I wanted it to be.  In 2014 and 2015 despite the XIV being down -9% and -17% respectively, the VTS Tactical Volatility Strategy gained 145% over those 2 years.

Then 2017 comes along and sidelines the strategy for nearly the whole year due to record setting low volatility.  Relentless suppressed volatility, and just when the markets gave us a glimmer of hope that we would get some elevated readings and get back into regular trading, a day later it would crash down again.

Frustrating to say the least…

 

Looking forward, all of my investing strategies are 100% data dependent.  I use a constant rolling data set and even though 2017 is likely just an outlier, all of those low volatility readings are now part of the rolling data set.  This means that the strategy itself and the rules that I set up for it many years ago don’t have to change very much.  I will still trade the strategy as I always have, targeting that middle range of volatility readings and trying to either avoid or hedge the rest of it through cash holdings and some VXX positions.

Now that a year of low volatility readings have joined the data set, it will mean that our thresholds are shifted down a little bit.  It won’t be night and day, it’s a decade long data set, but it will mean that it’s very likely to get into more trades in 2018.

 

The VTS Tactical Volatility Strategy still has a 25% allocation within the Total Portfolio Solution:

 

Current VTS Total Portfolio Solution Allocations

25% VTS Tactical Volatility Strategy

50% VTS Tactical Balanced Strategy

25% VTS Iron Condor Strategy

VTS Aggressive Vol Strategy  –  Optional replacement for higher risk tolerance investors

VTS Conservative Vol Strategy  –  Optional replacement for lower risk tolerance investors

 

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