Q4 2015 Strategy Report - Volatility Trading Strategies

Updated: Dec 6, 2018

While there were several moments when things were looking ugly within the broad markets, the signals weren’t quite strong enough to be in any long volatility trades  (VXX).  Also Fed talk about the eventual interest rate hike that took place in December kept volatility high enough that there were fewer than average short volatility  (XIV)  signals as well.  As a result, we were only in 34% of trading days this quarter.  This is in keeping with our philosophy that if no definitive trade signals exist, being in cash as an active position is the best choice.  We try to avoid the ambiguous middle ground of volatility signals as best we can and in this quarter it proved to be the prudent choice yet again as many other traders in the volatility space got steam rolled to significant losses.

Depending on ones point of view, we either have friends in the volatility space who do good work in expanding the understanding of the general public with regards to volatility products, or we have competitors that we strive to outperform.  Either way, there is some good work being done over at Volatility Made Simple that I wanted to borrow if I could to illustrate what kind of a year 2015 was for many traders.  I’m a regular follower of that blog for the performance updates he gives on many different trading strategies.  If you click the link and look at the column for 2015 final results you’ll notice that aside from three green ones it’s mostly a sea of red.  Notice as well that two of the three green positive results aren’t for actual strategies but are just for input signals that we also use  (VIX : VXV and VIX : Front month future)

So why was 2015 such a bad year for most traders?  It gets back to the same problem I’ve been talking about for several years.  Volatility signals can be very ambiguous, especially during times when there is no clear direction for the broad markets as a whole.  Since the S&P 500 spent most of the year chopping around and ended just about exactly where it started, there was no shortage of whipsaw signals being sent.  Most traders are binary, either long or short volatility but always in a trade.  This led to a great number of false positives that usually leads to losses in the long-run.

Now although we strongly prefer trending markets, since we don’t trade unless every one of our indicators is flashing the same signal we are also able to navigate non trending markets.  2015 was a great example of that, as we ended the year up 78%.

Looking forward, 2016 is likely to be another volatile year which if history is any indication means two things.  First, our trading will likely be less active than our competitors which is a good thing.  Secondly, we look forward to another strong year outperforming the broad markets and our fellow volatility traders out there.

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