I had a very interesting question yesterday:
“Why not buy and hold SVXY rather than time entries and exits? It seems as though the short vol position will play out over time and timing and commissions might be expensive.”
Longer term subscribers will know why we trade tactically and move in and out of positions depending on the market conditions at the time, but everyone is at a different point in their journey to understanding these complex volatility markets. So whether you’ve been with me for 5 years or 5 days, always feel free to ask any questions you have.
The short answer here Jeremy is that you’re absolutely right. When you said “the short vol position will play out over time” you are 100% spot on, it will. The part you’re missing is that we don’t want any part of where that leads because the short vol trade will play out to disastrous buy and hold performance. It always does. There’s no such thing as free money and shorting volatility isn’t a set and forget strategy. I would expect the return of blindly holding a short volatility trade over a few decades to be right around 0%.
SVXY chart since inception:
You can see that the SVXY isn’t actually up very much since it launched, barely more than a buy and hold on the S&P 500. And it might be tempting to look at that chart and say well if it wasn’t for February 5th of 2018 it would be doing fine. There’s a few things wrong with this:
1) You can see in the chart, from June 2014 through November 2016 the SVXY was in a drawdown. During a strong bull market period, it still went 30 months in a drawdown.
2) If we use simulated numbers going back to the launch of VIX futures in 2004 we can see that the SVXY buy and hold would have experienced a -92% drawdown which lasted 6 years. From February 2007 through January 2013 it was in a drawdown. That is a very long time to wait to break even. And of course, recessions are a perfectly normal part of the business cycle so expect this to happen again.
3) While it’s true the aftermarket rebalance of SVXY on Feb 5, 2018 was a disaster, even if we remove that it’s still having by far it’s worst year since inception.
Even if we are extremely generous and remove the aftermarket rebalancing on Feb 5 and chalk it up to a one time VIX futures liquidity crunch, it’s still down -42% this year without it. SVXY was down -9.3% in 2014 and -17.5% in 2015, but this year is shaping up to be by far and away the worst year on record.
So while it may be tempting to buy & hold a short volatility position and just hope that another Feb 5 event doesn’t happen again, the truth is even if it didn’t that doesn’t matter. Buy and hold SVXY will still see multi year drawdowns and ugliness that no investor could possibly tolerate.
SVXY launched on October 3, 2011 at a price of 5$. If I was a betting man I would put my chips on seeing a price fairly close to 5$ at some point during the next recession. That’s the nature of the short volatility trade. It’s not magic and the long-term expected return isn’t very much, if anything at all.
We need to be tactical if we are to capture consistent gains in the long-run. Moving in and out of positions to lock in profits when we can, as well as having a healthy amount of cash positions when the signals are ambiguous. While we do have our periods of underperformance and drawdowns (that’s the nature of all investing especially volatility investing) in my opinion trading tactically is the only viable option when dealing with a face ripper of an underlying asset like the SVXY.
Buy and hold SVXY has given up nearly all of it’s gains since 2011 and I have no doubt it will hand over the rest when the next recession finally hits. If we remain disciplined however, we can keep ours which is always the goal. Slow forward progress!
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