SVXY vs 1/2 Short VXX - Which is better for Volatility Traders?

VTS Community, 

Question:  Instead of buying SVXY in the Tactical Volatility Strategy, would it be better to Short VXX with a 1/2 allocation size?  Given that VXX decays a lot, wouldn't the long-term return be higher?

I love questions like this because there's no doubt finding small edges can add up to significant performance enhancements in the long-run.  Even if it's just a 1-2% boost it could really be substantial when compounded over an investing lifetime.  I also love questions where I can calculate and compare stuff so this is a fun question

The short answer is, NO, don't do that!  Let me explain

Remember, we use SVXY to represent our "Aggressive" positions within the Tactical Volatility Strategy:

SVXY vs Short 1/2 VXX

- SVXY is a -0.5x Inverse Volatility ETP

- VXX is a 1x Long Volatility ETP

So if we wanted to simulate the SVXY with Short VXX instead, all we would have to do is cut the allocation size in half and we would end up with something that at least on the surface is the same trade right?

The 1st thing we should do is just plot SVXY vs Short 1/2 VXX on a chart and see if there's a significant difference, and then from there we can talk about the MANY variables we have to consider:

1)  Borrow fees are not cheap

This will vary of course with the interest rate environment and how difficult to short the stock or ETF is.  If we're talking about about a very liquid stock or index, borrow fees can be less than 1%.  On something like VXX though it can be consistently expensive and at certain times when the rates spike up it can be prohibitively expensive.

As we can see in the above chart, the performance difference between SVXY and 1/2 VXX is about 1.5% give or take.  However, the annual borrow fees on VXX is definitely much higher than 1.6%.  It actually averages about 3-4% so this is definitely going to end up being a lower rate of return.

* Long term SVXY just performs better on its own than anything on the short side requiring an additional expensive fee to borrow

** The red line shows the borrow rate

2)  Shares can be hard to borrow

Again if we're talking about highly liquid stocks and ETFs this wouldn't be an issue.  However, in the Volatility ETP space these are often in the "hard to borrow" category and there's plenty of times there just won't be any shares available borrow. 

* For a systematic rules based strategy we need to have access to the underlying securities at all times, so hard to borrow is a total deal breaker.

3)  You're not in control of your shares

 When you short something you are essentially borrowing shares owned by someone else which means you are never in control of your own trade.  Those shares can be called away on you at any time. 

You could be in a trade one day and then just log in to your software and see that your trade was closed out on you WITHOUT your approval.  Those shares aren't yours, they are only lent to you as long as the situation with the controlling party doesn't change.  When it does, your trade is closed for you.

* Again, as a systematic trader, the possibility of having my trade closed out is a non starter.

4)  Shorting has unlimited loss

- When you're long a stock or ETF like SVXY, the maximum loss for your trade will be capped at 100%.  

- When you're short a stock or ETF you have unlimited loss.

Now that may not matter with respect to a stable stock or index, but with Volatility ETFs they can actually move substantial amounts if for example there was a flash crash or a cyber attack.  Best practises, it's never a good idea to be outright short any Volatility products, or any naked Options on Volatility products.  They have in the past, and they will again in the future, move hundreds of percent in a short amount of time.

* For this reason, shorting even a 1/2 allocation to VXX is a non-starter

Conclusion:

As I said, the short answer is no, don't ever short Volatility ETPs!

On the surface it may sometimes appear there is a small performance advantage, but that's only for the uninitiated.  More experienced investors know that when you take all the variables into account there's no doubt it is a substantially worse risk reward profile.  It's a rookie mistake!

• Borrow fees are high
• Shares can be hard to borrow
• Shares can be called away on you
• Shorting has unlimited loss

Click here for Video:  4 reasons not to short VXX/UVXY