Q4 2017 Strategy Report - Volatility Trading Strategies

Updated: Dec 6, 2018

We’ve been talking about it most of the year so why stop now.  2017 has been an unbelievably low volatility period.

A picture speaks a thousand words.  That’s a staggering amount of VIX index closes under 10 in 2017.  9 total from 1990 through 2016, and then 59 of them in a single year.  Just…  Wow.

VTS Total Portfolio Solution:

The Total Portfolio Solution had a decent bounce back in Q4 which was nice considering we’re coming off the worst quarterly return since 2012.  I’m always open and honest about the fact that drawdowns are a natural part of investing, but what’s most important is to keep the damage to a minimum and recover from bad stretches quickly and we’re well on our way.  The Total Portfolio Solution currently only includes a single volatility strategy in it’s performance but as I’ve eluded to a few times before, I’d like our performance to reflect everything I do and I’m planning on including all the strategies in the performance going forward.  If we would have done that the performance would have been substantially higher because the “optional replacement” strategies had a fantastic quarter so look forward to that change coming in 2018.

VTS Tactical Balanced Strategy:

Very little action here to speak of as we mainly just held equities to close out the year.  When volatility is in the gutter like it has been, IEF Bonds and GLD Gold positions aren’t necessary.  Since safety and risk management is the primary focus of this strategy, we’re just on cruise control until we get some signals that say otherwise.  Which if these past 9 years since the financial crisis have taught us anything it’s that the vibe of the market can change quickly so we’ll be ready for that switch when it comes.

VTS Tactical Volatility Strategy:

The last few months have been frustrating to say the least.  The Tactical Volatility Strategy was designed and launched in 2012 and has performed exceptionally well over the years through pretty much everything the market has thrown at us.  However the signals that I track don’t allow me to be in positions when the risk to reward ratio is so skewed to the risk side, as it is when volatility is this low for this long so we’ve mostly been sidelined in cash.  Also since tracking volume and long / short ratios is part of the strategy, the fact that it’s such a crowded trade on the short side also pushes me to cash most of the time.  I’ve also been reporting recently that XIV beta to the S&P 500 and to the VIX index is rising of late and it’s reaching somewhat worrying levels.  There’s not much I can say here that I haven’t said throughout the year.  Many articles, several videos, I’ve been warning of the dangers for months now explaining why the short vol trade is potentially riskier than people think.  It doesn’t help that there’s an army of so called “guru’s” all over Twitter pushing curve fitted backtests on the public making everybody wide eyed, but I’m going to stick to my guns and be conservative.  And all I can do is hope that our small but tight VTS community here heeds my warnings and stays conservative with me.

Just take my word for it, volatility won’t remain this low forever.  At some point the markets are going to bite back, and it’s possible the bite is hard.  Have we forgotten the 74% drawdown in 2011?  The nearly 70% drawdown in 2015?  Nearly 50% drawdown in 2014?  It wasn’t that long ago was it?  Something every volatility investor should know is you can never let your guard down.  When the inevitable volatility spike happens, whether it’s in four months or four years, all these people who think they can just short volatility with their eyes closed and laugh all the way to the bank are going to be in for a very rude awakening.  Now I definitely don’t want to sound like I’ll be happy when it happens because I won’t be.  I don’t ever want anybody to lose money.  That’s why I work so hard and take my position as a very public volatility strategist seriously.  But sometimes taking unexpected losses is a lesson people need to learn to avoid the really terrible stuff that’s lurking out there.

An analogy I’ve used plenty in the past but it’s apt right now, it’s like going to Las Vegas for the first time.  Honestly the best thing that could happen to you would be to lose your money quickly.  That way you’ll think long and hard about doing it again and IF you do make it back to the tables the next time around you’ll be far more disciplined.  It’s the same with volatility investing.  Sometimes taking a hard beat is the best thing for people.  If they do choose to continue dedicating a small portion of their portfolio to volatility investing  (as I personally do and I hope they do as well)  they’ll have fewer blind spots and know what the risks are.  As I’ve spoken about a lot this year, my biggest fear is that the short vol trade is crowded with people  (and investment strategists as well)  who haven’t even experienced a single drawdown yet.  Looking at the volume growth of the products, most people weren’t around during tough times, they’ve only seen this volatility in the gutter environment.  I take my job and my influence seriously so I’ll always try to bring people back to the conservative side.

end rant/

VTS Iron Condor Strategy:

Low volatility is not a friendly environment for selling Iron Condors.  As we know, Iron Condors are vega negative trades.  That means they profit when volatility declines.  The issue is when volatility is already in the gutter as it’s been for all of 2017 there’s no where else for it to go but sideways or up.  Now sideways is fine but it has to persist.  Even the slightest little volatility bump can stop-out a trade and we experienced that this past quarter.  However one of the reasons we trade a diversified portfolio is so that we always have strategies to pick up the slack when something is struggling.  This past quarter was not kind to Iron Condors, but our core Balanced and Volatility strategies picked up some of that slack.  And there will be times when those struggle and we’ll need our market neutral Iron Condors to step up and save the team.

VTS Conservative Vol and VTS Aggressive Vol:

Our “optional replacement” strategies are designed for those with a different level of risk tolerance than the main Tactical Volatility Strategy provides.  The Conservative Vol strategy is even more conservative.  It takes roughly the same amount of trades as the Tactical Volatility but it does so with the ZIV and VXZ which are slower moving products.  They focus on the 4th to 7th month of the VIX futures and the curve that far out tends to move less day to day making the ZIV in general a safer product.  The Aggressive Vol on the other hand takes a higher percentage of trades, over 70% in fact so during solid trends like we saw throughout Q4 it can do quite well.  These optional replacement strategies are not restricted from trading low volatility environments and as a result, both of them did very well this past quarter.  As I mentioned they are not included in the Total Portfolio Solution performance but they will be soon.  Subscribers will be choosing the strategy that best reflects their own personal level of risk tolerance but I would like all three represented in our performance reports.

Here’s hoping a little volatility returns to the market in 2018 and beyond…

Trade history for the past quarter for all our strategies

VTS Tactical Volatility performance in Q4:  2.71%

VTS Aggressive Vol performance for Q4:  41.24%

VTS Conservative Vol performance in Q4:  16.64%