Short VXX vs Long VXX Put options - Part 2. What happens during crashes?

Jul 25, 2019

VTS Community,

In yesterday's blog I went through all the math showing why the rate of return for our most recent VXX Put option position was virtually the same as what the return would have been had we just shorted the VXX outright. After the appropriate capital adjustments and delta factor, both earned about 7% for a 3 week trade, pretty solid. It seems we can conclude that during winning trades:

Short VXX = VXX Put options. Performance was the same

But, that was a successful winning trade. The next question is, which one of those performs better in the event of unsuccessful losing trades?

When markets tank and volatility spikes, is a trader better off holding short VXX? Or is the damage mitigated better by holding VXX put options instead? Let's go through three examples of periods that included large volatility spikes:

* Note: I'm using split adjusted prices for all examples

* Also, whenever I do articles backtesting negative performance there's always a few follow up comments asking why I did so bad. So I want to make clear, these are just backtests, nothing to do with my own performance. In truth, my results were positive through these three events I'm showing, so this is just a backtest.

August 3rd, 2015 - August 24th, 2015:

The first few weeks of August 2015 were calm and uneventful. But then with two of the largest VIX spikes in history back to back on August 21st and August 24th (46% and 45% respectfully) it quickly became a month that few volatility traders will ever forget. Fortunately I picked up on the signals early and my Tactical Volatility strategy made a very nice +26% profit for that month. But it's a good month to see what would have happened if a trader was unfortunately short volatility during that period.

  • VXX at market close on Aug 3, 2015: 252.48

  • VXX at market close on Aug 17, 2017: 389.92

  • Short VXX rate of return over that time period: -54.44%

Holding VXX Put options instead, using the Tactical Volatility strategy stock replacement method: -28.02%

August 1st 2017 - August 17th 2017:

August 2017 caught a lot of volatility traders by surprise, including yours truly. Those big VIX spikes on August 10th (44%) and August 17th (32%) weren't well telegraphed ahead of time which is rare. Typically I can pick up on the signals before the spike and move to safety, but the one on August 10th was just out of nowhere. Let's compare short VXX vs VXX Put options during that period. 

  • VXX at market close on Aug 1, 2017: 44.20

  • VXX at market close on Aug 17, 2017: 54.64

  • Short VXX rate of return over that time period: -23.62%

Holding VXX Put options instead, using the Tactical Volatility strategy stock replacement method: -14.87%

January 16th, 2018 - February 6th, 2018:

Volpocalypse! Who can forget? On February 5th, 2018 the VIX index spiked 115.6% and killed our old friend the XIV in a single death blow. I did give several warnings in the year leading up to it, and here at VTS we side stepped it nicely and actually made a small profit in Feb 2018, but it was one for the record books for sure. What would have happened if a trader was short volatility?

  • VXX at market close on Jan 16, 2018: 27.44

  • VXX at market close on Feb 6, 2018: 42.88

  • Short VXX rate of return over that time period: -56.27%

Holding VXX Put options instead, using the Tactical Volatility strategy stock replacement method: -29.13%

Why are VXX Put options so much safer?

Why is this happening? Why do the VXX Put options perform better than short VXX does during a crisis?

In a word, Vega

Remember, the Tactical Volatility strategy uses long only puts and calls on the VXX, which are long volatility, long Vega trades.

* Vega is the Greek symbol representing volatility. Long Vega means the underlying option benefits from increases in volatility.

When there is a significant market crash, volatility spikes up quickly, and even though when that happens it is very painful indeed to be holding short volatility positions, actually that positive Vega benefits the trade and offsets some of those losses.

Obviously not nearly enough to make it profitable, but you can see from the three examples above (and every example from the last 10 years since VXX launched) holding the VXX Put options instead mitigates a pretty good chunk of that damage.

Trading the volatility ETPs directly, VXX, SVXY, ZIV, VXZ, VIXY etc is definitely the easier route since they can be bought and sold just like regular stocks. There's definitely an advantage there which is why they have become so popular in the last several years.

However, simulating long and short volatility ETP positions with stock replacement through options has it's advantages as well. Every individual needs to weigh their own level of risk tolerance to make the best decision, but that's why I have a family of volatility strategies to choose from. Everyone can match up the strategy to their long term goals.


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