How to allocate VXX Options in the Tactical Volatility strategy

Nov 11, 2020

The Tactical Volatility strategy launched in January 2012, and used the old ETF called XIV for all short volatility positions all the way through until it was terminated in February 2018. Since that Volpocalypse event, we've used stock replacement with VXX options instead. Using options has a lot of advantages, as you can learn more in this video: VXX Puts vs Short VXX

Stock replacement with options has a few steps we follow:

  • a) We choose an underlying with liquid options, and VXX has a solid options market so fill prices are very efficient.
  • b) To combat the negative effects of Theta decay, we keep the contracts well out into the future, which is why we chose the 19 Mar 21' contract with 130 days to expiration.
  • c) We choose an in the money Put strike with a Delta factor of between 0.5 - 0.7. The 25 strike Put we bought has a Delta of 0.51
  • d) If we catch a trend and the trade is held open to within about 75 days to expiration, we will rebalance by moving the trade further out in time again.
  • e) IMPORTANT: We reserve the full capital required to hold the underlying VXX shares. It's this final step that needs further explanation. 

When buying the option, it's going to be far cheaper than buying the VXX shares. 1 option contract is equal to 100 shares, and the official end of day price for the 25 strike option we bought was 8.55.

That means it only costs 855$ to buy 1 option contract. But with VXX trading at around 19$ when the email went out, it would cost roughly 1,900$ to buy 100 shares of VXX directly.

If a trader were to use all their allocated capital for the strategy to buy the options, they would end up with many more option contracts than equivalent underlying shares, making it a leveraged position which we don't want.

So we reserve the full capital required to hold the underlying shares, to make sure that our options contract allocation is roughly equal to the underlying ETF allocation.

With VXX trading around 19$ when the email went out, that means it would require 1,900$ to buy 100 shares.

  • VXX factor = Current VXX price * 100
  • VXX factor = 19$ * 100 = 1,900$

That's why in yesterdays email I said:

"Buy 1 option contract per 1,900$ in available capital"

You just take whatever amount of capital you have reserved for the strategy, and buy 1 option contract per 1,900$ you have. This will scale your trade correctly and make sure you are not taking on a leveraged position.

Example 1) If you had 25,000 to trade the Total Portfolio Solution

- The Tactical Volatility strategy is a 20% allocation, meaning you'll have 5,000$ to follow the Tactical Volatility strategy.

  • Scaling: Available capital / VXX factor = contracts
  • Scaling: 5,000$ / 1,900$ = 2.63 contracts

Always round down to the nearest full contract, and in this example the trader would buy 2 contracts of the 19 mar 21' VXX 25.00 Put

Example 2) With 100,000 to follow the Total Portfolio Solution

- Tactical Volatility strategy would get 20,000$ of that money

  • Scaling: Available capital / VXX factor = contracts
  • Scaling: 20,000$ / 1,900$ = 10.53 contracts

Round down, and this trader buys 10 option contracts.

In the daily emails I will always give you the VXX factor. Again that's calculated simply by taking the current VXX price * 100. With just that VXX factor, you can easily scale your trade.

Scaling: Available capital / VXX factor = contracts

Trust me, when you do a few of these it will be just as fast as any other trade you have. You'll just look at the option contract we're buying, take your capital and divide by the VXX factor, and buy that many contracts. It shouldn't take more than a couple minutes :)

For video explanations instead, you can check out the series:


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