Updated: Dec 6, 2018
If you follow any volatility specific blogs or twitter feeds, you've no doubt been inundated with commentary about just how difficult an environment it's been in 2018. They aren't wrong, it has been and I've been talking about it as well. We're doing ok this year considering the bloodbath in global markets (more on that tomorrow) but let's just try to put some numbers to all this talk of terrible performance. First, let's check in on our volatility specific benchmark that we use to measure our own performance against.
CBOE Eurekahedge Short Volatility Index
You can see that with two months to go, it's actually setting up for it's worst year ever. Short vol hedge fund managers are not very happy this year, but let's check the other side of that coin.
CBOE Eurekahedge Long Volatility Index
Interestingly, the long vol index isn't doing that well either and this goes to the heart of the issue this year. Neither a short vol nor a long vol bias has worked.
But what about if a trader understood some basic concepts like contango and backwardation? This is something that is often quoted, that you just short volatility when the VIX futures term structure is in contango, and you go long volatility when the opposite is true and it's in backwardation.
Does that really work?
The "contango only" signal has shown some serious whipsaw action in 2018 and has been absolutely crushed, down -38%. So clearly this often repeated bit of advice that one only needs to look at the term structure to profit is dead on arrival. It's one of those things that sounds clever and sophisticated, taking about VIX futures and M1 M2, contango, but it actually doesn't work.
But surely in a year like 2018 when we add in the long vol trades during backwardation, that will help recover some of those losses that just the short side alone suffered right?
Nope, that would have just made the whipsaw action even more prevalent. So it's been a tough year for nearly every asset class, volatility, stocks, bonds, precious metals, real estate, commodities, oil recently (yikes) but we've done alright and that's mostly due to how much we've just stayed in safety positions. This is one of the things that separates my investing style from the crowd.
No strategy works in all environments, that's impossible. The problem is, most people don't have the discipline to just wait for the right pitch to come across the plate. They end up stepping out of the box trying to swing at anything, and it ends up being very costly. If we maintain discipline, even ugly years like 2018 don't have to ruin all previous progress.
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