Sunday, January 16, 2011

VIX Has Reached a Level That Normally Precedes an Uptick in Volatility

We all know the VIX is very low; this fact has been talked about ad nausea lately.  And by looking at the yellow bands, the volatility contraction is rather clear. I'm not so much concerned with how low the actual price (static) is, but more with the relative price action (dynamic). Today I'm using Bollinger Bands to observe a potential short term extreme in the $VIX. The definition and explanation of Bollinger Bands can be found on the creator's website. Bollinger Bands ("BB") are one measure of volatility; so why not measure the volatility of volatility (via the VIX).  You can set this indicator to measure just about any period length and standard deviation, but right now I'm just looking at 20 periods and 2 standard deviations (this is the default parameter BTW).

On 1-14-11, the VIX closed below its BB (20,2). When it touches this level, where does volatility (VIX) usually head over the next week?


Buy VIX when it close below Bollinger Band (20,2) ; sell 'n' days later. $10,000 per trade; 1995 to present.
Exit n
 days
Net Profit
# Trades
# of winners
% of Winners
Max. Trade % DD
Avg % P/L
W. Avg. Profit
L. Avg. Loss
Profit Factor
Payoff Ratio
1
    19,055.92
80
53
66.25
-5.96
2.38
      490.59
  (257.23)
3.74
1.91
2
    36,353.22
72
60
83.33
-8.55
5.05
      690.55
  (423.30)
8.16
1.63
3
    41,257.07
70
51
72.86
-11.87
5.89
      917.59
  (291.57)
8.45
3.15
4
    45,586.29
70
52
74.29
-13.92
6.51
  1,005.72
  (372.84)
7.79
2.70
5
    47,518.96
66
45
68.18
-16.27
7.20
  1,266.88
  (451.94)
6.01
2.80

Over the last 15 years, if you could buy [you can't though because it's not tradable as an index] the VIX when it hit this level, you could've made money holding anywhere from 1 to 5 days. Bottom line: odds point to an increase in volatility this week. With all the new VIX products out there, there are many new ways to play the VIX action - so have at it!

Now since the S & P 500 and VIX usually work inversely to each other, here's how the SPY performed when the VIX hit the low level like it did on Friday.


Buy SPY when VIX closes below Bollinger Band (20,2) ; sell 'n' days later. $10,000 per trade; 1995 to present.
Exit n
 days
Net Profit
# Trades
# of winners
% of Winners
Max. Trade % DD
Avg % P/L
W. Avg. Profit
L. Avg. Loss
Profit Factor
Payoff Ratio
1
       (286.61)
80
36
45.00
-3.32
-0.04
        70.01
    (63.79)
0.90
1.10
2
    (2,009.39)
72
33
45.83
-4.74
-0.28
        85.16
  (123.58)
0.58
0.69
3
    (3,186.98)
70
34
48.57
-5.79
-0.46
        90.56
  (174.05)
0.49
0.52
4
    (3,381.93)
70
34
48.57
-5.85
-0.48
        86.29
  (175.44)
0.46
0.49
5
    (4,630.95)
66
29
43.94
-6.72
-0.70
      103.73
  (206.46)
0.39
0.50

              
The SPY has not performed too well under these conditions. You don't get killed, but it's probably not the best time to go heavy on the long side.

These are some things to keep in mind for this upcoming (holiday shortened) week. Remember to consider your own relevant trading factors before acting and that the past doesn't always predict the future .

Good trading out there.
---------------------------------------------------------------------------------------------------------------------

Extra tidbit:

One extreme to the next: If you had the intestinal fortitude to buy the VIX on a close below BB (20,2) but sold only when it closed above BB (20,2), here is how it would go. (Average hold is 30 days)


Buy when VIX when on close below BB (20,2); sell on close above BB (20,2) $10,000 per trade; 1995 to present.

Net Profit
# Trades
# of winners
% of Winners
Max. Trade % DD
Avg % P/L
W. Avg. Profit
L. Avg. Loss
Profit Factor
Payoff Ratio
1
        89,869
43
37
86.05
-41.33
20.90
      2,648
    (1,349)
12.10
1.96

12 comments:

inversorX said...

this last statistic is ok, but you calculate teh vix spot?

we can´t trade that...

Chris said...

inversorX - I know. I've mentioned it in other posts, but not this one. Any "trade" of the VIX is purely hypothetical because you can't actually trade it. These studies (on the VIX especially) just get the mental juices flowing. The idea is that volatility will probably go up this week, but it's up to everyone to determine any action to take. There are many new products available to exploit VIX movement, see VixandMore. Thanks for the comment.

Jzz said...

I wonder whether the result would be similar for VXX (VIX ETF)

Contrarian said...

Sorry Chris you are right and I should supposed it. But it was late here in Spain and my mind was sleeping.

InversorX from other account.

Chris said...

Contrarian - no worries. You made a very good point anyway. I updated the post to make it clearer.

Jzz - the VXX is is an option, but it doesn't exctly follow VIX movement well. VXX is only 2 years old, so not a lot of data there. These VIX ETF's are interesting beasts; they operate in a peculiar way. @agwarner just wrote this re VXX and VXZ.

http://dailyoptionsreport.com/2011/01/16/ugly-vxx-and-vxz-redux/

derek said...

good stuff, thanks for sharing!

Anonymous said...

The VIX always goes down before 3 day weekends and then we pops up the next week. Its a statistical quirk. That said, I do agree we should see a pop pretty soon beyond the statistical quirk.

Woodshedder said...

Looks like we were thinking about the same things over the weekend. Good post.

David said...

Chris, just came across your blog and was interested in what you've said about yourself. I quit my day job last year to trade full time (it took me 8 years to get there though) and I use mechanical systems similar to the ones you said you're trying to develop: a longterm trendfollowing system for stocks (for bull markets), an iron condor system (for sideways markets), and a calendar spread system (for bear markets). All these systems are longer term systems, but patience isn't a problem for me because so many trades are made each month. Happy to discuss...

alysomji said...

Chris, I would like to email you to ask you a few questions. But, I don't know your address. Please drop me a line: aly dot somji at gmail dot com

Thanks!

Chris said...

David - I primarily trade short term systems, but if you want to talk more, contact me simplequant at gmail dot com

maquant said...

Chris, interesting mean reversion approach to volatility. But what I don't understand: why is the number of trades decreasing with the holding period? The entry criteria is the same. Do I miss something?

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