Impossible Cupcakes

The ideas I sketch out every afternoon are fanciful sweet little things, decorated to perfection.

Then someone ventures a bite and sometimes finds that that's all they are.

Fanciful.

Readers are fantastic guinea pigs!

Ilya got in touch about this post about diversification and rightly mentioned that it is impossible to actually invest in the Vix.

In any case, I looked at investable alternatives and see how they faired.

The two big ETF hitters are VXX (a short term future ETN) and VXZ (its medium term cousin).

As you can see, as the VIX keeps beating away, our ETF buddies are starving to death.

The technical terminology is 'a mouldy bear'.

So, if these two ETFs do follow a mean reverting process, they have well and truly reverted already, and are in need of a jolt.

How do you make money from either of these?

No chance over such a short time period.

Perhaps if I had more data, there would be a better story to tell.

The only investable long Vix index that hasn't tanked in recent history is the S&P DJ Vix Term Structure Index.

It's secret is that it shorts the short end of the Vix curves (VXX) and doubles down long on the medium part of the curve (VXZ) - reminds me of Avellaneda's work.

So, assuming we still have some mean reversion available to us, each day we do a similar inverse weighting as before,

1/SPVXTSTR

i.e. the currently available level of the Term Structure index.

Over the last 6 years the S&P had a Sharpe of 0.6, adding a splash of SPVXTSTR brings the Sharpe to 0.86.

Max Wait is 3 of the 6 years total.

To put this in context, the equally weighted portfolio benchmark results in a Sharpe of 0.75.

Not the same orthogonal style diversification benefits as the previous strategy - mainly because SPVXTSTR only profits when the Vix is in contango.

During highly stressed times the Vix goes into backwardation meaning Vixness evaporates just when you think it should really kick in.

Worth more investigation nevertheless.

If only I had more data to back test over more periods when the Vix is in backwardation.

Code for the Lazy Backtesting IDE is here.