EC Strategies For Trading Inverse Volatility

The parameters for this strategy have been optimized in QuantShare. The Bollinger band period is 20 days and the upper line is at 1.4. If VXX crosses the upper line I will exit (cover) VXX the next day at open. If VXX goes below the middle line, then I go short VXX the next day at open.

You can also use two SMA lines with 15 and 5 days and sell or cover at the crossings. The return is more or less the same as for the Bollinger strategy.

You can also do such strategies with XIV which is the inverse of VXX. However, the maximum annual return which I could achieve is 84% per year, which is 12% less than with VXX. This lower performance is mainly due to time decay losses which are quite strong for such volatile ETFs.

So, this is quite a simple strategy. You can even set a stop at the level of the upper Bollinger band line + 1%, so that the exit is automatic in case something very bad happens.

The Cautious Investor Medium Term Inverse Volatility Strategy

The two strategies above are for traders willing to check their investments on a daily basis. If you do not want to do this because you like to go on long holidays or you just don't like to look every day at your PC screen then it is better to invest in the medium term inverse volatility. You can do this by going long ZIV or going short VXZ. VXZ has higher volume than ZIV but the results are similar.

VXZ and ZIV have less than half the volatility (vola=25) than VXX or XIV (vola=55). Also, the contango structure is more stable than for the front month. Also, during the fiscal cliff crisis last month, the midterm futures never went into backwardation.

You can also use a Bollinger or SMA trading system for these ETFs. You will achieve about 44% annual return trading VXZ and you can do so with less than half of the volatility. This way you have about the same return to risk ratio as if you had traded the VXX.

However, because the volatility and behavior of ZIV or VXZ is very similar to the stock market, you can also include for example ZIV in a rotation strategy. In such a strategy it is a ranking mechanism which will tell you when to exit ZIV. This is normally better than using moving averages because the switching points are much smoother.

Investing in Medium Term Inverse Volatility with the "Maximum Yield Rotation Strategy"

A strategy I employ which gets most of its return from inverse volatility is the Maximum Yield Rotation Strategy which I presented in Seeking Alpha around two months ago. With such a strategy you can outperform a simple ZIV or VXZ SMA strategy by up to 20% per year. The advantage is that you only need to check the ranking of the ETFs every two weeks. No need to check daily the VIX term structure or the ZIV charts. Rotation strategies are very sensitive to changing market environments.

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