VIX [Cboe Volatility Index]

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Paisley
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VIX [Cboe Volatility Index]

Post by Paisley » Tue May 14, 2019 9:50 am

Does anyone have experience with investing in the VIX - (VXX ETF, 2x ETFs, Inverse ETFs, Options, Futures, etc.)?
If so, have you have any success? I've got a friend who was looking at this index and I was wanting to give him input.

Thanks!

Beliavsky
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Joined: Sun Jun 29, 2014 10:21 am

Re: VIX

Post by Beliavsky » Tue May 14, 2019 10:11 am

Paisley wrote:
Tue May 14, 2019 9:50 am
Does anyone have experience with investing in the VIX - (VXX ETF, 2x ETFs, Inverse ETFs, Options, Futures, etc.)?
If so, have you have any success? I've got a friend who was looking at this index and I was wanting to give him input.
VIX and therefore VIX futures tend to rise when the stock market falls, so you could buy VXX as protection against stock market drops. It did rise 15% on Monday. However, the historical returns of being long VIX futures have been quite negative. If you want to lose less when the stock market falls, own less stock.

Shorting VIX futures is profitable on average but has unlimited risk, since VIX is uncapped. It is simpler and safer to just be long the S&P 500.

Unless your friend is a quant who understands options theory well and can program a backtest of a strategy, he should stay away from VIX products. I am such a person but am currently staying away myself.

JackoC
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Re: VIX

Post by JackoC » Tue May 14, 2019 2:41 pm

Paisley wrote:
Tue May 14, 2019 9:50 am
Does anyone have experience with investing in the VIX - (VXX ETF, 2x ETFs, Inverse ETFs, Options, Futures, etc.)?
If so, have you have any success? I've got a friend who was looking at this index and I was wanting to give him input.

Thanks!
This page at CBOE's site might be of interest.
http://www.cboe.com/products/strategy-b ... -index-vpd
It lists and gives historical data for 'VIX related strategy benchmarks'.

For example the VPD index is selling short the VIX futures each month. That generally makes money over time, losing back big chunks when the VIX spikes. This kind of strategy might work though in a Taleb type 'barbel' where a small % of capital was allocated to supporting shorting the VIX, and a high % to completely safe assets. Big blowups would only (in theory at least) wipe out that small % of capital, which would earn a high return in general (risk aversion means that VIX futures generally trade at a premium to the spot VIX and converge to it at futures contract maturity, IOW in commodities futures-speak the VIX is usually in contango).

Then it has a capped version of that strategy where you also short the VIX futures but buy an out-of-the-money call on the VIX to limit the downside.
But again either of those are still relatively high downside strategies it would be imprudent to add to an already equity-heavy portfolio. They might make sense, subject to further study and understanding by the investor, as the high risk part of an otherwise highly conservative portfolio.

The index most interesting to me at the moment is VXTH, a tail hedging strategy which holds the S&P then buys calls on the VIX for various %'s of portfolio depending on the level of the VIX. In this benchmark it's no hedge when the VIX (front futures) is <15% on the observation that really big market blow ups have been rare with a low VIX. It buys out of the money ('30 delta') VIX options costing 1% of portfolio per month when the VIX futures are between 15 and 30%, on the observation that a lot of stock market blow ups have occurred with the VIX in that range. It buys lower %'s with higher VIX (again historically a lot of the upside from owning the VIX in a downturn has been realized by the time it reached 30 or 50%). Such an index invites comparison to other weightings and how they have performed historically, or to strategies like those of Universa Investments and their main guy Mark Spitznagel which involve buying certain combinations of below-the-money stock index puts in a monthly pattern, depending on market valuation. In any case of tail hedging the return of the hedge is likely to be negative unless your data set includes a lot of past blow ups, or there are a lot of them in the future. Anyway it will lose out if things go smoothly. The potential benefit is by being able to increase your equity allocation without fully commensurate increase in downside risk. So like any other such idea, if you already like 100% naked equity exposure but don't want to lever (a not uncommon expression of risk tolerance on this forum, though give or take whether people who say they are '100% stock' *really* are...), there would be no value in either VXTH or Universa's ideas.

Anyway like Beliavsky said, I doubt this is something for investors who have to ask 'do you know anything about this?' to actually do without a considerable period of study first. Also I'd say in general there's a correlation where if it seems too daunting to understand the pricing, and trading for yourself, of the futures and options instruments involved, then you probably shouldn't be buying packaged (ETF etc) products doing it for you either. An attractive strategy in the real world pretty-but-not-totally efficient market will usually be only moderately attractive and therefore vulnerable to becoming unattractive via fees if you can't DIY.
Last edited by JackoC on Tue May 14, 2019 2:53 pm, edited 1 time in total.

ohai
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Re: VIX

Post by ohai » Tue May 14, 2019 2:46 pm

I have tons of experience with VIX and VIX derivatives. Long story short is your friend should not do it, because he won't understand how it works. Even if he does understand it, he will either not have access to adequate trading systems or will decide their are better ways to trade whatever he's doing.

BJJ_GUY
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Re: VIX

Post by BJJ_GUY » Wed May 15, 2019 11:24 am

Avoid the ETFs unless there is a very specific reason. I can't really think of one.

If you boil down what institutional investors (hedge funds, sophisticated endowments, Canadian pensions, etc.) are doing, it might explain why even the underlying exposure from ETFs are undesirable - even before the structural flaws.

For equity like risk/return you sell-puts. This is referred to as harvesting the volatility risk premia. This is not a hedging/diversifying strategy, but should be part of an equity allocation as it has the same inherent risks

Tail protection you can buy OTM calls on VIX. Many also trade VVIX (the volatility of volatility) via options, although this isn't straight forward, so maybe stick to VIX calls. (SPX options, and many other fit the bill too, but trying to stick to VIX for the topic.)

The problem with using futures to obtain a 'hedge' through VIX products is that futures have linear payoffs where as OTM calls have positive convexity which will provide the long volatility profile one would expect from an instrument acting as something of an insurance policy. (For those not following, as the VIX increases, the long out-of-the-money call will increase in value at an increasing rate.)

Beliavsky
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Re: VIX

Post by Beliavsky » Wed May 15, 2019 5:11 pm

BJJ_GUY wrote:
Wed May 15, 2019 11:24 am
The problem with using futures to obtain a 'hedge' through VIX products is that futures have linear payoffs where as OTM calls have positive convexity which will provide the long volatility profile one would expect from an instrument acting as something of an insurance policy. (For those not following, as the VIX increases, the long out-of-the-money call will increase in value at an increasing rate.)
No, VIX futures and therefore ETFs tracking them are linear in VIX, but VIX is nonlinear in SPX, so VIX futures DO have positive convexity with respect to SPX. To demonstrate this empirically, you could regress VXX (an ETN that tracks a long position in short-term VIX futures) returns on SPY returns and squared SPY returns:

VXX_ret = c0 + c1*SPY_ret + c2*SPY_ret^2

You will find c1 is negative (VXX goes up when SPY goes down) and that c2 is positive (VXX has positive convexity).

Topic Author
Paisley
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Re: VIX

Post by Paisley » Wed May 15, 2019 8:44 pm

Unless there is some sort of sophisticated hedge as has been mentioned, I cannot see how someone can hope to make money over the long term. Maybe fits and spurts if you happen to buy at good times but even then you gotta get out FAST!

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arcticpineapplecorp.
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Re: VIX

Post by arcticpineapplecorp. » Wed May 15, 2019 8:58 pm

Paisley wrote:
Wed May 15, 2019 8:44 pm
Unless there is some sort of sophisticated hedge as has been mentioned, I cannot see how someone can hope to make money over the long term. Maybe fits and spurts if you happen to buy at good times but even then you gotta get out FAST!
exactly. because often some of the worst days in the market are followed by the best days.
source: https://www.google.com/search?client=fi ... the+market
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

Topic Author
Paisley
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Re: VIX

Post by Paisley » Wed May 15, 2019 9:27 pm

The kind of analysis and focus required is over the top for folks who are not in front of a computer all day. Not worth the risk.

Cyclone
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Re: VIX

Post by Cyclone » Wed May 15, 2019 9:44 pm

I tinkered with this once (on paper). I thought maybe you could invest, let's say, 10 percent in a VIX ETF and 90 percent in an S&P 500 ETF and the VIX would go up when the market went down. I don't remember why, but that didn't seem to work.

BJJ_GUY
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Re: VIX

Post by BJJ_GUY » Wed May 15, 2019 11:51 pm

Beliavsky wrote:
Wed May 15, 2019 5:11 pm
BJJ_GUY wrote:
Wed May 15, 2019 11:24 am
The problem with using futures to obtain a 'hedge' through VIX products is that futures have linear payoffs where as OTM calls have positive convexity which will provide the long volatility profile one would expect from an instrument acting as something of an insurance policy. (For those not following, as the VIX increases, the long out-of-the-money call will increase in value at an increasing rate.)
No, VIX futures and therefore ETFs tracking them are linear in VIX, but VIX is nonlinear in SPX, so VIX futures DO have positive convexity with respect to SPX. To demonstrate this empirically, you could regress VXX (an ETN that tracks a long position in short-term VIX futures) returns on SPY returns and squared SPY returns:

VXX_ret = c0 + c1*SPY_ret + c2*SPY_ret^2

You will find c1 is negative (VXX goes up when SPY goes down) and that c2 is positive (VXX has positive convexity).
I believe you confusing correlation with convexity?

Convexity refers to the asymmetric payoff profile of options. Futures and cash instruments (equity/bonds) are all linear. This is important to understand, at least basically, as it helps explain why ETPs backed by VIX futures are suboptimal as tail protection exposure.

ETNs are not capital efficient vehicles for hedging in the first place, creating a double whammy: Inefficient means of gaining exposure to VIX futures, when you really want downside protection through options in a 20% drawdown scenario.

BJJ_GUY
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Re: VIX

Post by BJJ_GUY » Thu May 16, 2019 12:07 am

Paisley wrote:
Wed May 15, 2019 8:44 pm
Unless there is some sort of sophisticated hedge as has been mentioned, I cannot see how someone can hope to make money over the long term. Maybe fits and spurts if you happen to buy at good times but even then you gotta get out FAST!
Using the ETNs discussed, you are correct. They are not money good.

A systematic put-selling strategy produces long term results similar to equity. The volatility risk premia is persistent, and this strategy is widely accepted as a viable equity replacement strategy, meaning it could sit right next to your SPX holding and thought of similarly for asset allocation.

If you were to combine the Vol risk premia strategy with some upside calls plus defensive exposure to OTM calls on VIX, OTM puts on SPX then you have what is a very crude approximation of what many volatility arbitrage funds are doing. In greek speak this strategy is short gamma, locally, and positive convexity on the tails.

BJJ_GUY
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Re: VIX

Post by BJJ_GUY » Thu May 16, 2019 12:13 am

Cyclone wrote:
Wed May 15, 2019 9:44 pm
I tinkered with this once (on paper). I thought maybe you could invest, let's say, 10 percent in a VIX ETF and 90 percent in an S&P 500 ETF and the VIX would go up when the market went down. I don't remember why, but that didn't seem to work.
A few ideas that come to mind immediately...
ETNs try to track the daily movements so volatility can mess up multi-day holding periods. Also, because of the calendar mismatch between VIX calculation and VIX futures dates there can be mismatch. More importantly, the futures market can experience price movements that are entirely dislocated from the VIX (for the most obvious example of this, go back to Feb 2018 and re-read about how all the inverse VIX products spiraled out of control and had to be immediately terminated).

NotTooDeepLearning
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Re: VIX

Post by NotTooDeepLearning » Thu May 16, 2019 1:08 am

Here's a good starting point for inverse volatility trading strategies: http://volatilitymadesimple.com/categor ... backtests/

BJJ_GUY
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Re: VIX

Post by BJJ_GUY » Thu May 16, 2019 1:52 am

NotTooDeepLearning wrote:
Thu May 16, 2019 1:08 am
Here's a good starting point for inverse volatility trading strategies: http://volatilitymadesimple.com/categor ... backtests/
How did that strategy do, in live trading, in 2018? Strangely, I can't find even model results beyond 2017. Maybe I'm looking in the wrong spot.

NotTooDeepLearning
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Re: VIX

Post by NotTooDeepLearning » Thu May 16, 2019 2:07 am

BJJ_GUY wrote:
Thu May 16, 2019 1:52 am
NotTooDeepLearning wrote:
Thu May 16, 2019 1:08 am
Here's a good starting point for inverse volatility trading strategies: http://volatilitymadesimple.com/categor ... backtests/
How did that strategy do, in live trading, in 2018? Strangely, I can't find even model results beyond 2017. Maybe I'm looking in the wrong spot.
That link presents the backtests of many strategies only through the "great recession." Most of them got completely wiped out in 2018 (I tested many myself using current data). But several of them survived the financial crisis and February of 2018. That is of course no guarantee the surviving strategies won't be wiped out in the future. It's definitely a very dangerous game.

BJJ_GUY
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Re: VIX

Post by BJJ_GUY » Thu May 16, 2019 2:32 am

NotTooDeepLearning wrote:
Thu May 16, 2019 2:07 am
BJJ_GUY wrote:
Thu May 16, 2019 1:52 am
NotTooDeepLearning wrote:
Thu May 16, 2019 1:08 am
Here's a good starting point for inverse volatility trading strategies: http://volatilitymadesimple.com/categor ... backtests/
How did that strategy do, in live trading, in 2018? Strangely, I can't find even model results beyond 2017. Maybe I'm looking in the wrong spot.
That link presents the backtests of many strategies only through the "great recession." Most of them got completely wiped out in 2018 (I tested many myself using current data). But several of them survived the financial crisis and February of 2018. That is of course no guarantee the surviving strategies won't be wiped out in the future. It's definitely a very dangerous game.
The most dangerous thing I noticed is they are using ETPs for exposure to the volatility risk premia (VRP). The problem isn't the fact that VRP strategies get smacked when and by a (somewhat) similar magnitude as equity markets.

Did they ever come back and explain how they learned how/why ETPs investing in VIX futures are not a great way to access VRP? As you likely know, if you read these type of websites, the flaws with VIX referencing ETPs was widely known; not a secret. Although, to be fair, I've never seen this website, so they could have warned people about all this and that model you linked on here was just for fun. Would be curious if you know?

Beliavsky
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Re: VIX

Post by Beliavsky » Thu May 16, 2019 8:55 am

BJJ_GUY wrote:
Wed May 15, 2019 11:51 pm
Beliavsky wrote:
Wed May 15, 2019 5:11 pm
BJJ_GUY wrote:
Wed May 15, 2019 11:24 am
The problem with using futures to obtain a 'hedge' through VIX products is that futures have linear payoffs where as OTM calls have positive convexity which will provide the long volatility profile one would expect from an instrument acting as something of an insurance policy. (For those not following, as the VIX increases, the long out-of-the-money call will increase in value at an increasing rate.)
No, VIX futures and therefore ETFs tracking them are linear in VIX, but VIX is nonlinear in SPX, so VIX futures DO have positive convexity with respect to SPX. To demonstrate this empirically, you could regress VXX (an ETN that tracks a long position in short-term VIX futures) returns on SPY returns and squared SPY returns:

VXX_ret = c0 + c1*SPY_ret + c2*SPY_ret^2

You will find c1 is negative (VXX goes up when SPY goes down) and that c2 is positive (VXX has positive convexity).
I believe you confusing correlation with convexity?

Convexity refers to the asymmetric payoff profile of options. Futures and cash instruments (equity/bonds) are all linear. This is important to understand, at least basically, as it helps explain why ETPs backed by VIX futures are suboptimal as tail protection exposure.
No, I did not confuse correlation with convexity. To repeat myself, VIX futures are linear in VIX, but they are not linear in SPX, because VIX is not linear in SPX. If you doubt me do the regression I mentioned in a spreadsheet. VXX rises more when SPX falls 5% than it falls when SPX gains 5%. That positive convexity wrt SPX is why VXX has negative expected returns, even adjusting for its negative beta. You can have positive SPX convexity by being long VIX futures or long SPX straddles, but you have to pay for it either way.

BJJ_GUY
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Re: VIX

Post by BJJ_GUY » Thu May 16, 2019 10:20 am

Beliavsky wrote:
Thu May 16, 2019 8:55 am
BJJ_GUY wrote:
Wed May 15, 2019 11:51 pm
Beliavsky wrote:
Wed May 15, 2019 5:11 pm
BJJ_GUY wrote:
Wed May 15, 2019 11:24 am
The problem with using futures to obtain a 'hedge' through VIX products is that futures have linear payoffs where as OTM calls have positive convexity which will provide the long volatility profile one would expect from an instrument acting as something of an insurance policy. (For those not following, as the VIX increases, the long out-of-the-money call will increase in value at an increasing rate.)
No, VIX futures and therefore ETFs tracking them are linear in VIX, but VIX is nonlinear in SPX, so VIX futures DO have positive convexity with respect to SPX. To demonstrate this empirically, you could regress VXX (an ETN that tracks a long position in short-term VIX futures) returns on SPY returns and squared SPY returns:

VXX_ret = c0 + c1*SPY_ret + c2*SPY_ret^2

You will find c1 is negative (VXX goes up when SPY goes down) and that c2 is positive (VXX has positive convexity).
I believe you confusing correlation with convexity?

Convexity refers to the asymmetric payoff profile of options. Futures and cash instruments (equity/bonds) are all linear. This is important to understand, at least basically, as it helps explain why ETPs backed by VIX futures are suboptimal as tail protection exposure.
No, I did not confuse correlation with convexity. To repeat myself, VIX futures are linear in VIX, but they are not linear in SPX, because VIX is not linear in SPX. If you doubt me do the regression I mentioned in a spreadsheet. VXX rises more when SPX falls 5% than it falls when SPX gains 5%. That positive convexity wrt SPX is why VXX has negative expected returns, even adjusting for its negative beta. You can have positive SPX convexity by being long VIX futures or long SPX straddles, but you have to pay for it either way.
I'm not entirely sure the point you are trying to make. Do you understand that what I'm saying is that futures (as a general instrument) are linear, and that options are not?

Honestly, I'm not sure what part of that general point you are challenging. In all seriousness, I'm interested in learning because it sounds like you know more than I do here.

PS... when you say VXX has positive convexity based on the SPX regression, is that actually the correct takeaway? Or is this explained by VIX futures being short vol of vol -- and the delta of a VIX future not being 1, and being variable over both price and time? The relationship you point out is statistical, but not exactly explanatory. (I think this was what you were getting at, but if I'm off, then definitely don't take it the wrong way).

Beliavsky
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Re: VIX

Post by Beliavsky » Thu May 16, 2019 1:06 pm

BJJ_GUY wrote:
Thu May 16, 2019 10:20 am
Beliavsky wrote:
Thu May 16, 2019 8:55 am
BJJ_GUY wrote:
Wed May 15, 2019 11:51 pm
Beliavsky wrote:
Wed May 15, 2019 5:11 pm
BJJ_GUY wrote:
Wed May 15, 2019 11:24 am
The problem with using futures to obtain a 'hedge' through VIX products is that futures have linear payoffs where as OTM calls have positive convexity which will provide the long volatility profile one would expect from an instrument acting as something of an insurance policy. (For those not following, as the VIX increases, the long out-of-the-money call will increase in value at an increasing rate.)
No, VIX futures and therefore ETFs tracking them are linear in VIX, but VIX is nonlinear in SPX, so VIX futures DO have positive convexity with respect to SPX. To demonstrate this empirically, you could regress VXX (an ETN that tracks a long position in short-term VIX futures) returns on SPY returns and squared SPY returns:

VXX_ret = c0 + c1*SPY_ret + c2*SPY_ret^2

You will find c1 is negative (VXX goes up when SPY goes down) and that c2 is positive (VXX has positive convexity).
I believe you confusing correlation with convexity?

Convexity refers to the asymmetric payoff profile of options. Futures and cash instruments (equity/bonds) are all linear. This is important to understand, at least basically, as it helps explain why ETPs backed by VIX futures are suboptimal as tail protection exposure.
No, I did not confuse correlation with convexity. To repeat myself, VIX futures are linear in VIX, but they are not linear in SPX, because VIX is not linear in SPX. If you doubt me do the regression I mentioned in a spreadsheet. VXX rises more when SPX falls 5% than it falls when SPX gains 5%. That positive convexity wrt SPX is why VXX has negative expected returns, even adjusting for its negative beta. You can have positive SPX convexity by being long VIX futures or long SPX straddles, but you have to pay for it either way.
I'm not entirely sure the point you are trying to make. Do you understand that what I'm saying is that futures (as a general instrument) are linear, and that options are not?
Suppose there was a futures contract that settled to log(SPX) on expiration day. Those futures would be linear in log(SPX) but nonlinear in SPX. In fact they would have negative convexity wrt SPX, because d^2/dx^2 log(x) = -1/x^2.

bizkitgto
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Re: VIX

Post by bizkitgto » Thu May 16, 2019 1:21 pm

OP needs to look into $XIV...a cautionary tale!
Keep it simple: 20% BND, 50% VTI and 30% VXUS

BJJ_GUY
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Re: VIX

Post by BJJ_GUY » Thu May 16, 2019 4:57 pm

Beliavsky wrote:
Thu May 16, 2019 1:06 pm

Suppose there was a futures contract that settled to log(SPX) on expiration day. Those futures would be linear in log(SPX) but nonlinear in SPX. In fact they would have negative convexity wrt SPX, because d^2/dx^2 log(x) = -1/x^2.
Okay, let me try this again. When I'm talking about investment strategies as a hedge to the rest of a portfolio, I'm looking for a set of trades (or.an investment manager) who will generate a return stream that is:
1. Uncorrelated to equity
2. Asymmetric (you can lose a small premium to make a large payoff
3. Positive convexity... meaning the larger the (negative) event the exponentially higher the pay-off
4. Long volatility

If you believe an ETN that invests in VIX futures - and a strategy investing in longer dated >10 delta SPX puts - will provide the same asymmetric and convex pay-off in the event of markets tanking and implied volatilities doubling.... well, then I don't know what to say.

*By the way, I understand the statistical point you are making, it's just that you are answering an entirely different question. That doesn't really make any difference, or move the needle in the smallest way when it comes to comparing a $100 investment in VXX vs $100 investment in long-dated OTM puts -- in a scenario where equity is down big and vol spikes. Not even close.

JackoC
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Re: VIX

Post by JackoC » Thu May 16, 2019 5:30 pm

Beliavsky wrote:
Thu May 16, 2019 8:55 am
BJJ_GUY wrote:
Wed May 15, 2019 11:51 pm
Beliavsky wrote:
Wed May 15, 2019 5:11 pm
BJJ_GUY wrote:
Wed May 15, 2019 11:24 am
The problem with using futures to obtain a 'hedge' through VIX products is that futures have linear payoffs where as OTM calls have positive convexity which will provide the long volatility profile one would expect from an instrument acting as something of an insurance policy.

No, VIX futures and therefore ETFs tracking them are linear in VIX, but VIX is nonlinear in SPX, so VIX futures DO have positive convexity with respect to SPX.
I believe you confusing correlation with convexity?

Convexity refers to the asymmetric payoff profile of options.
No, I did not confuse correlation with convexity. To repeat myself, VIX futures are linear in VIX, but they are not linear in SPX, because VIX is not linear in SPX.
I agree. To try to explain it another way without math and perhaps bridge the gap between the two positions, the positive convexity of being long the VIX *is* a 'correlation', something that's observed to generally be true as opposed to true per a strict math relationship (like a futures contract on Log (SPX), etc). Nonetheless the key point is what you said is true in general as a practical fact.

There might be a world where the process of stock price movements and risk preference of investors made the VIX uncorrelated to the S&P. There could be a world where the VIX was negatively correlated to the S&P but the VIX tended to move up about 5% when the S&P moved down 5%, and vice versa for down VIX/up S&P. But in the real market, since the VIX has been calculated, it's as you say: the VIX generally moves up a significantly greater % when the S&P sells off 5% than when the S&P trades up 5%. IOW long VIX has positive convexity relative to the S&P. Thus in an efficient market the VIX futures tend to trade at a premium to the market's actual expectation of the VIX's value as of the futures contract expiration date. Thus being long VIX futures tends to act like buying index options on the S&P. When things go fairly close to expected, ie most of the time, you lose money on the convergence of the VIX futures price to the spot VIX or the VIX declines and you lose. If the market tanks you get a disproportionate payoff on the futures. It's analogous to losing the premium you spend to buy out of the money puts on the S&P most of the time, and big payoffs when it tanks.

Of course being long VIX futures is not exactly the same as any given strategy of buying particular index options (put v call, given amount out of the money, etc) but it's basically the same way around...positive convexity.

And as illustrated on the page I linked earlier from CBOE, one can track the history of various strategies employing options *on the* VIX, not just VIX futures, either as a way of taking risk to get return (short the VIX futures, with or without buying out of the money calls on the VIX), or trying to reduce tail risk (with for example a program of buying call options on the VIX as in the VXTH index). One can then compare these VIX based strategies to particular analogous, not identical, index option buying or selling strategies which are trying to accomplish similar goals.

Beliavsky
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Re: VIX

Post by Beliavsky » Thu May 16, 2019 7:59 pm

BJJ_GUY wrote:
Thu May 16, 2019 4:57 pm
Beliavsky wrote:
Thu May 16, 2019 1:06 pm

Suppose there was a futures contract that settled to log(SPX) on expiration day. Those futures would be linear in log(SPX) but nonlinear in SPX. In fact they would have negative convexity wrt SPX, because d^2/dx^2 log(x) = -1/x^2.
Okay, let me try this again. When I'm talking about investment strategies as a hedge to the rest of a portfolio, I'm looking for a set of trades (or.an investment manager) who will generate a return stream that is:
1. Uncorrelated to equity
2. Asymmetric (you can lose a small premium to make a large payoff
3. Positive convexity... meaning the larger the (negative) event the exponentially higher the pay-off
4. Long volatility
Suppose the beta of VXX to SPX is -5. Then long $100K of SPY and long $20K of VXX has the attributes above, for the most part.

BJJ_GUY
Posts: 154
Joined: Wed Mar 13, 2019 7:45 am

Re: VIX [Cboe Volatility Index]

Post by BJJ_GUY » Thu May 16, 2019 8:57 pm

Closer! At least we're now thinking about investment return, prospectively.

Close enough for me.. PY + VXX.. satisfies 2 of the 4 conditions. It's negative-to-uncorrelated with equities, and at least VXX is long volatility.

Still lacks a return profile that is asymmetric and positively convex.

I know the relationships weaken with VIX futures but the idea of the actual instrument is to provide a linear return that is driven by the change in the underlying (VIX, for this purpose it doesn't matter how it relates to SPY). Because ETNs are fully funded at investment, and because the product is linear in nature, I don't think we could find any ETFs that would easily offer the insurance type trade of risking small premium amounts for many multiples of return on paid in capital that are available through long-dated OTM puts

I feel like we could have been on the same page from start if maybe I made the distinction between futures and options, and precisely why I'm calling that positive convexity. Most basically, futures lack delta, gamma, Vega, characteristics which is exactly what I mean by linear vs non-linear. But think of convexity as = gamma x Vega (I'm definitely guessing here because I know that has it's own term combing the two words). Either way, I want the options that generate increasing returns, but also at an increasing rate to best hedge at the very best time.

** I'm fully aware you know the terms of the greeks. I was trying to articulate where I should have started at the beginning of this. Also, just so anyone who might read this can follow my attempt at using these greeks I have thought of in years

NotTooDeepLearning
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Re: VIX

Post by NotTooDeepLearning » Thu May 16, 2019 11:27 pm

BJJ_GUY wrote:
Thu May 16, 2019 2:32 am
NotTooDeepLearning wrote:
Thu May 16, 2019 2:07 am

That link presents the backtests of many strategies only through the "great recession." Most of them got completely wiped out in 2018 (I tested many myself using current data). But several of them survived the financial crisis and February of 2018. That is of course no guarantee the surviving strategies won't be wiped out in the future. It's definitely a very dangerous game.
The most dangerous thing I noticed is they are using ETPs for exposure to the volatility risk premia (VRP). The problem isn't the fact that VRP strategies get smacked when and by a (somewhat) similar magnitude as equity markets.

Did they ever come back and explain how they learned how/why ETPs investing in VIX futures are not a great way to access VRP? As you likely know, if you read these type of websites, the flaws with VIX referencing ETPs was widely known; not a secret. Although, to be fair, I've never seen this website, so they could have warned people about all this and that model you linked on here was just for fun. Would be curious if you know?
Why are ETPs a bad way to access VRP in general? (I did not read all the math heavy stuff above :P) That website did mysteriously stop producing material in 2008.

Beliavsky
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Re: VIX

Post by Beliavsky » Fri May 17, 2019 7:04 am

NotTooDeepLearning wrote:
Thu May 16, 2019 11:27 pm
Why are ETPs a bad way to access VRP in general? (I did not read all the math heavy stuff above :P) That website did mysteriously stop producing material in 2008.
A general problem with a short or leveraged long ETP is that it requires daily trading to maintain the leverage. XIV was an ETP that aimed to harvest the VRP by shorting front month VIX futures, with leverage of -1. If your fund is short $1 billion of VIX futures (I believe XIV did get this big), and if VIX futures have risen 50% on the day, then your fund is now worth $0.5 bil, and you can only be short 0.5/(150%) = 1/3 of your original VIX futures contracts and must buy back 2/3 of them. However, if the size of your fund is large relative to the size of the VIX futures market, buying back 2/3 of your positions will cause VIX futures to rise still higher. On February 5, 2018, such hedging caused VIX futures to rise more than what the moderate SPX decline would have predicted, and this caused XIV to fall 90% and be delisted. You can Google "xiv imploded Feb 5 2018" for articles such as Anatomy of a Blowup – How a Volatility Spike in February Destroyed XIV & SVXY.

JackoC
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Re: VIX [Cboe Volatility Index]

Post by JackoC » Fri May 17, 2019 9:58 am

BJJ_GUY wrote:
Thu May 16, 2019 8:57 pm

Still lacks a return profile that is asymmetric and positively convex.

I know the relationships weaken with VIX futures but the idea of the actual instrument is to provide a linear return that is driven by the change in the underlying (VIX, for this purpose it doesn't matter how it relates to SPY). Because ETNs are fully funded at investment, and because the product is linear in nature, I don't think we could find any ETFs that would easily offer the insurance type trade of risking small premium amounts for many multiples of return on paid in capital that are available through long-dated OTM puts
Long VIX futures absolutely is positively convex with respect to the S&P, and it absolutely matters how the VIX relates to the S&P. The VIX, a measure of a characteristic of a derivative on the S&P (prices of options on the S&P) is mainly relevant in relation to the S&P.

Also more basically your argument seems to imply the term 'convexity' inherently implies only to options and that's not true. Convexity simply means a change in value that's not linear with respect to a change in some other relevant financial variable. Owned bonds with no embedded options are still positively convex with respect to interest rates. So are treasury note futures and interest rate swaps. Whereas long dated Eurodollar futures are not convex wrt interest rates but linear, and that creates a noticeable valuation difference between long dated Eurodollar contracts and interest rate swaps for the same dates. 'Convex or not' does not map 1:1 onto 'option or not'.

Being long VIX futures isn't necessarily *as* convex wrt S&P as very out-of-the-money index options on the S&P, but neither are at-the-money index options as convex as far out-of-the-money ones, nor is the convexity of a given option constant over time. And OTOH one can leverage the payoff of VIX futures by DIY'ing* and putting up less capital than the packaged products do, whereas you have to pay in cash for options. Which particular strategy is the most convex is not the point, but whether there's significant convexity in VIX futures. Yes, wrt S&P movements, and the VIX itself is important mainly in terms of S&P movements.

VIX futures are convex wrt the S&P and this is not an arcane point because that consistent payoff behavior is what causes VIX futures to trade persistently above the market's expectation of the future VIX, which is fundamental for any investor interested in using VIX instruments to understand. Being long the VIX has a built in drag of convergence of VIX futures prices to the spot VIX, to compensate shorts for the negative convexity (wrt the S&P), otherwise nobody would go short.

*I reiterate my doubt that anybody should pursue strategies like this with packaged products. If an investor doesn't have the understanding, time, set up, etc to trade VIX futures (or options on the VIX, or options on the S&P) themselves, I doubt they should pay somebody else to do it for them via a packaged product. Which isn't to say anybody necessarily has to do anything like this at all, but packaged products for relatively simple leverage, convexity, etc strategies seldom make sense IMO so there's no reason for them to be at the center of a conceptual discussion.

Beliavsky
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Re: VIX [Cboe Volatility Index]

Post by Beliavsky » Fri May 17, 2019 10:17 am

JackoC wrote:
Fri May 17, 2019 9:58 am
*I reiterate my doubt that anybody should pursue strategies like this with packaged products. If an investor doesn't have the understanding, time, set up, etc to trade VIX futures (or options on the VIX, or options on the S&P) themselves, I doubt they should pay somebody else to do it for them via a packaged product.
I agree with you regarding ETPs that are short VIX futures or that are leveraged long VIX futures, but VXX, which is long VIX futures without leverage, seems ok to me. The only trading it needs to do is to continually scale out of the front month VIX futures contract and into the second, and if you wanted to be long VIX futures as a tail risk hedge, you would need to do the same thing.

Chadnudj
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Re: VIX [Cboe Volatility Index]

Post by Chadnudj » Fri May 17, 2019 10:32 am

There is some excellent research (see Griffin and Shams) and some current lawsuits pending in federal court showing/alleging that the VIX is susceptible to manipulation (and, indeed, has been manipulated).

Stay far away.

Beliavsky
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Re: VIX [Cboe Volatility Index]

Post by Beliavsky » Fri May 17, 2019 10:48 am

Chadnudj wrote:
Fri May 17, 2019 10:32 am
There is some excellent research (see Griffin and Shams) and some current lawsuits pending in federal court showing/alleging that the VIX is susceptible to manipulation (and, indeed, has been manipulated).

Stay far away.
A recent working paper The VIX Volatility Index - A Very Thorough Look at it mentions the paper you cite. It is true that strange things happen at VIX settlement, but one can avoid this by not holding VIX futures into the settlement. Most VIX futures traders will have rolled into the next contract before expiration, and that is what VXX does also. In general, futures markets participants, whether they are speculators or hedgers, usually do not hold contracts until expiration.

Chadnudj
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Re: VIX [Cboe Volatility Index]

Post by Chadnudj » Fri May 17, 2019 11:10 am

Beliavsky wrote:
Fri May 17, 2019 10:48 am
Chadnudj wrote:
Fri May 17, 2019 10:32 am
There is some excellent research (see Griffin and Shams) and some current lawsuits pending in federal court showing/alleging that the VIX is susceptible to manipulation (and, indeed, has been manipulated).

Stay far away.
A recent working paper The VIX Volatility Index - A Very Thorough Look at it mentions the paper you cite. It is true that strange things happen at VIX settlement, but one can avoid this by not holding VIX futures into the settlement. Most VIX futures traders will have rolled into the next contract before expiration, and that is what VXX does also. In general, futures markets participants, whether they are speculators or hedgers, usually do not hold contracts until expiration.
Fair, but there are non-settlement dates (see Feb. 5, 2018) where manipulation is suspected/has been alleged, as well.

If I'm investing, I'm staying far away from any instrument pegged to an index that has a high potential for manipulation.

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