Q4 2014 Strategy Report - Volatility Trading Strategies

Updated: Dec 6, 2018

The markets are finally without their training wheels as we’ve seen the completion of the FED’s quantitative easing program  (at least for now)  and with it came a very interesting divergence in the market.  While the S&P 500 weathered the transition reasonably well being up almost 5%, the XIV and the volatility markets took a big hit.  Being as objective as I can be, it was a tough month for volatility traders that really put some trading systems to the test.  There’s a few things that have been re-enforced in my mind after this successful quarter we had:

  •  We are correct in our contention that trades need to be more scrutinized than simply being long or short volatility.  We were only in the market for 30% of the days last quarter and because of this, we came out with a tidy profit while many of the other trading systems I follow were substantially down  (some on the order of -30%)  There were just far too many ambiguous signals last quarter that were troublesome for our more aggressive peers.

  • Mean reversion strategies only work in theory, and unfortunately that theory only existed in a world of curve fitted back tests being stretched back to 2004.  In the real world of live trading, they work until they don’t.  The VIX can and does get stretched and most of the time it does mean revert which is what these systems are based on. But every so often it will reach those extreme levels where you expect mean reversion to kick in, and instead it snaps and goes further against you. Oversold can and does become more oversold.  You can bleed a substantial amount of capital waiting for mean reversion to kick in.  We only had a glimpse of what can happen, but at some point in the next 5 years we will see a clear break to the downside.

VTS Tactical Volatility finished 2014 with a 37.3% profit which speaks to our focus on risk management.  Maybe I’m a pessimist, but with each passing year I feel we are getting closer and closer to a major market decline.  Is it coming in 2015?  We’ll see.

Thanks for another great year everybody.

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