Wrapping up this week in review for all our Volatility Trading Strategies, today we’ll go over the VTS Conservative Vol Strategy. The big question I want to try to answer today is:
What makes the VTS Conservative Vol Strategy “conservative?”
When looking at the performance of the 3 strategies side by side, one might be inclined to think it’s simply because it has the lowest rate of return:
Not that 40% is a slouch, but that’s quite conservative compared to the other two. However that’s not it. The real answer is because it trades two different underlying ETPs which are inherently more conservative in the way they are calculated:
ZIV – VelocityShares Daily Inverse VIX Mid-term
VXZ – iPath S&P 500 Mid-term Futures
These products are different because they derive their price based on a rolling of the 4th – 7th months of the VIX futures (orange circle) instead of the more common 1st – 2nd month (green circle) like the XIV and VXX.
Since the VIX futures term structure is typically flatter further out in time at the 4th – 7th month, the ZIV and VXZ actually tend to move less from day to day compared to the front month ETPs like XIV and VXX (and SVXY and VIXY as well)
So the strategy isn’t conservative because I am shooting for a lower rate of return. It’s conservative by the very structure and the way ZIV and VXZ are calculated.
This will likely lead to a lower rate of return in the long-run this is true, but the trade off is the drawdowns may be far less as well which makes the “risk adjusted return” quite attractive.
The ZIV is typically more insulated against broad market corrections as well because it takes quite a significant VIX spike to push the 4th – 7th month futures into backwardation (an inverted term structure). Only when market participants fear the effects will be more long term does it actually invert the curve.
The same cannot be said for the front 2 months where we’ve seen things as small as a tweet or a news report push those front two months backward.
Here’s a comparison of (M2 : M1) vs (M7 : M4)
You can see how much more rare it is for the M7 : M4 futures that the ZIV trades to go into backwardation. Again market participants will only start pricing the risk that far out when whatever is scaring the market is perceived as being a potentially more long lasting issue.
The European debt crisis in 2011 as well as the strong sell off in late 2015, both pushed even the furthest month VIX futures backward. Other than that though it was fairly smooth sailing.
I know in the era of Bitcoin, fast money and euphoric markets, a conservative volatility strategy that only returns double digits isn’t the sexiest thing in the world, but 9 years into the 2nd longest bull market in history, I don’t think there is anything wrong with boring.
Current VTS Total Portfolio Solution Allocations
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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