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Only 1 In 20 "Skilled" Traders Profit From VIX ETFs

Tyler Durden's picture




 

Submitted by Salil Mehta via Staistical Ideas blog,

Our last article, Volatility-product hitmen, provoked a number of enthusiastic comments about how it should be easy to benefit from volatility exchange-traded products.  The technical lingo in the counterarguments suggest they are likely from groping investment trading individuals.  But how likely is it that these individuals are able to extract the divine trading signals, similar to what they have proposed?  To answer this, we must first create a view for what fraction of the time these traders are able to implement any such "profitable signal" from the future curve (say in the past couple of years).  Would a quarter of the time be sufficient to warrant having such a new-age, exchange traded strategy?  We'll start with this assumption, and in this article below we'll debunk the conviction of these commentators - with two charts.  Instead we show over the past 2 years that only less than 5% of users of these derivative products, such as mass-market available volatility ETFs, would have earned a skilled profit from it (as opposed to from haphazard guessing).  So at best, only 1 in 20 people.

First let's study the past two years of the VIX volatility index.  We can see from the chart on the previous blog article link above, that the VIX was in a slight uptrend.  It rose from about 14% in mid-February 2013, to about 15% in mid-February 2015.  Also see this, Eruptions in market volatility note, about changes in volatility patterns along the way.  So there should have been some opportunities for users of pro-volatility ETFs to benefit.  While in the previous article we explored both the VXX, and UVXY, we'll be generous here and only explore further the less-leveraged VXX.

In the chart below we show the sampled distribution of 1-day returns for both the VIX, and the VXX.  See the arithmetic returns first (grey for VIX, and dotted blue for VXX).  The VXX distribution is less spread-out, and its typical value is slightly negative (each day bleeding a fraction of a percent).  Note that these are histogram frequencies with 5% units.  So "0%" represents -5%, to 0%.

 
Returns on 1-day VIX versus 1-day VXX
 

Now let's discuss the difference between the arithmetic return versus the geometric return.  Say one had a financial product that produced the following return over two days:

day 1           --> -25%
day 2           --> +25%
 
adding (-25% +25%) = 0% but this is misleading, since
total return --> (1-25%)*(1+25%) - 1 = (3/4)*(5/4) - 16/16 = -1/16 (or -6.3%)

What we illustrate above is the flaw with studying arithmetic returns for more than a single period.  Instead, we must use geometric returns instead for representation and convert all data to exponential form.  So day 1 would convert to ln(1-25%)=-29%, and day 2 would convert to ln(1+25%)=22%.  Now it's easy to see that -29%+22% is more closely resembles the -6% we seek.

For the chart above, for small values in a 1-day period, this difference is not noticeable with the naked eye.  But the difference become greater when there are inevitably larger market swings over time.  And another benefit from the exponential approach (as we see in the example above) is that one can more easily sum these returns over time.

So let's carry over our 1-day geometric returns for the VXX.  In the chart below we also show how the returns appear for different time frames.  Say a 5-day, 25-day, and 125-day period.  Given the lack of serial correlation in the VXX returns (Durbin-Watson statistic of 2.0), we can interpret the n-day statistics as any result of combining anyone's alleged "winning" signals together.  The results would be the same that is, for someone who had 125 single-day signals in the past two years, as it is for someone with a 5 signals to hold the VXX for 25-days each.

 
Returns on n-day VXX

What the results show are a few important, probability conclusions.  The first is that the amplification of the subtle decay of the VXX (between 0%-1% daily loss), even though the VIX rose over the course of the past two years.  Notice for example that the 125-day distribution is about 5 times worse than the 25-day distribution?

Next, we notice that while the 1-day returns were positive just under 50% of the time, the 5-day returns were positive about 40% of the time, the 25-day returns were positive about 35% of the time, and the 125-day returns were positive about 10% of the time.

In other words, for anyone trading the VXX on signals they see about 25% of the days (or 125-130 days every bi-annual period), it is unlikely that they would be actually generating positive returns due to either luck or skill.  The Bayesian math tools for this are shown here (and last year featured in a popular New York Times article).  So there is somewhat less than 10% chance of someone being able to claim success here in being a skilled trader.  Further, there is a high likelihood that on the "non-signal" periods that these same traders would be engaged in loss trades due to their dominating and imperfect use of the product (this would not be attributed as haphazard guessing).  From these two we have less than 5% probability of seeing a skilled user of the product profit from these ETFs.

So at best, 1 in 20 users of these modern products such as VXX product over the past two years.  And the odds worsen if we do any combination of these four things: (A) assume any futures curve trading signal is greater than 25% of the time, (B) we extend the time frame of trading beyond two years, (C) if we switch to other more levered products such as UVXY, or (D) if we inch closer to the assumption one is a typical individual and not a purported skilled trader.  Also if we assume the opposite of bullet (A) above and believe the trader is using VXX for less than 25% of their signals, then we must ask the equally damning question of whether any of this is worth anyone's time to begin with.  Going from 25% to 15% for example, would give the small fraction of skilled traders (as opposed to anyone who claims to be a trader) the return distribution between the 125-day and the 25-day.  And that's not great.

 

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Wed, 06/10/2015 - 15:35 | 6183552 Bobbo
Bobbo's picture

19 born every minute, and [x] to take them?
Oh, yes, and a lucky 1 for the tasty demo!

Wed, 06/10/2015 - 15:42 | 6183609 HedgeAccordingly
HedgeAccordingly's picture

ROFL .. yes.. and Citadel Et al. make millions if not billions selling options on these instruments which the peon's buy

Wed, 06/10/2015 - 17:18 | 6184036 Say What Again
Say What Again's picture

How many skilled traders are there in this statistical sample?  How many are there in the USA, the world?

Wed, 06/10/2015 - 16:18 | 6183803 Low Tech Future
Low Tech Future's picture

I only traded VIXY once and made a little, but did not know what I was doing.

 

There is your 5%

Wed, 06/10/2015 - 16:18 | 6183804 Low Tech Future
Low Tech Future's picture

I only traded VIXY once and made a little, but did not know what I was doing.

 

There is your 5%

Wed, 06/10/2015 - 15:31 | 6183555 kaiserhoff
kaiserhoff's picture

Unclear on the concept.

The whole point of trading VIX, especially in the last, oh, 30 minutes on a low volume day...,

  is to manipulate the damn market.

Wed, 06/10/2015 - 15:33 | 6183565 Grinder74
Grinder74's picture

You're trying too hard.  The trend is your friend.  

Wed, 06/10/2015 - 21:38 | 6184858 Gohn Galt
Gohn Galt's picture

Exactly.  I know they were not talking UVXY in this post, but it is a stupid simple trade.  Shorting UVXY works 90% of the time, it is made to go down in value.  Of course watch the charts and do not buy and hold.  Get in make your money and cash out and wait for your next entry.

Wed, 06/10/2015 - 15:36 | 6183579 Catullus
Catullus's picture

I've lost my ass on them.

Dragon farts. That's what's in there. It's an etf of dragon farts.

Wed, 06/10/2015 - 15:36 | 6183585 oudinot
oudinot's picture

Vix is but a fix

A crafty trix,

From Fed pricks,

so Bears get licked.

 

 

Wed, 06/10/2015 - 15:37 | 6183590 FreeShitter
FreeShitter's picture

The vix....lol

Wed, 06/10/2015 - 15:39 | 6183591 TheRideNeverEnds
TheRideNeverEnds's picture

The VIX is meant to go down and stocks are meant to go up, they are inverse.  You cant win buying and holding VIX products like VXX just as you cant lose buying indexed etfs like SPY.  VIX stuff is gonna have much more drag on it as well due to this whereas SPY issues you a dividend.  

 

Since most people go long things this is no surprise. 

Wed, 06/10/2015 - 15:52 | 6183654 taketheredpill
taketheredpill's picture

 

 

 

Basically another source of bank funding.

Wed, 06/10/2015 - 16:39 | 6183715 IntercoursetheEU
IntercoursetheEU's picture

Recently, shorting VXX has been a more rational decision, but "hope springs eternal".

Going long VXX is quite tricky, but not always unwarranted. Three conditions MUST exist to even consider it -

1) The VIX needs to be below $12.50, preferably lower, nearing historic lows

2) SPX needs to be plowing into new highs at least 5% above the previous peak, and showing a sharp ascending curve

3) VXX must be well into new low territory, giving time to shake off any short covering from any recent gyrations. If conditions one and two are met this is virtually assured, but not guaranteed.

Be prepared to give up some ground if the trade appears to not be going your way. You do not want to hold on to these shares for long. The article is correct, because the times when all three conditions are met are exceedingly rare... but also exceedingly rewarding.

Wed, 06/10/2015 - 16:04 | 6183720 asteroids
asteroids's picture

The article is fudamentally flawed. The reason why we apply statistical methods is that we don't know with 100% certainty the behaviour of the object of study. We assume uncertainty and randomness.  As loyal ZH readers know the VXX is under complete control of the boyz and their supercomputers. Hence, any fool using the VXX will have his head handed to him. They boyz control VXX witrh 100% certainty and slam it up and down at will to inflict maximum pain., therefore the article is useless.

Wed, 06/10/2015 - 18:22 | 6184260 OLD YELLER
OLD YELLER's picture

I belive that what you have said is accurate. Remember that they also employ very skilled traders as well, once removed in the grey area of the trading floor, displaying an uncanny sense of timing as they play the mice creully before the kill. 

Take your money to a good reputiable horse track, bet progressive on the nose, and enjoy the day!

Cheers!

Wed, 06/10/2015 - 16:08 | 6183751 SqueezeMe
SqueezeMe's picture

Short them instead of buying and bingo, 95% of trades are winners.

Wed, 06/10/2015 - 18:04 | 6184201 chomu
chomu's picture

Duh, and there's a damn good reason that TV is crazy high on OTM puts. The put writers know that its a piece of shit going to $0.00.

Better to pay the lending costs and short the shares through a PB

Wed, 06/10/2015 - 18:11 | 6184225 chomu
chomu's picture

And here's a Buffet-style bet for you:

Go LONG XIV and SHORT VXX for the next 10 years. 

Pretty much 99.9% probability that the trade will beat the S&P and every hedge fund out there and produce positive alpha.

Wed, 06/10/2015 - 16:13 | 6183779 socalbeach
socalbeach's picture

Calculating arithmetic returns (-25% + 25%) is ok as long as your bet size stays constant.  But if you always bet 100% of your current portfolio for example, then yes you have to use geometric returns (3/4 * 5/4).

Wed, 06/10/2015 - 16:36 | 6183874 socalbeach
socalbeach's picture

Let's say you start out with $10K and you always bet half of what you have.  So to start you bet $5K and if you win you end up with $15K, and if you lose you end up with $5K. Even if you win 60% of the time you will eventually end up broke.

 

Wed, 06/10/2015 - 18:11 | 6184223 ElixirMixer
ElixirMixer's picture

Which is why this article misses the point entirely. VIX is always and forever an insurance product. And why deal with an ETF when you can just buy the options if you actually need to use it.

Wed, 06/10/2015 - 16:21 | 6183816 Glass Seagull
Glass Seagull's picture

 

 

Why anyone needed to do analysis on this old issue is beyond me. 

 

Wed, 06/10/2015 - 16:38 | 6183888 The Axe
The Axe's picture

The worst product ever conceived.....

Wed, 06/10/2015 - 16:50 | 6183935 PeeramidIdeologies
PeeramidIdeologies's picture

When behind the smoke, there was a mirror and its reflection was much clearer...

Wed, 06/10/2015 - 17:06 | 6184002 TheGreatRecovery
TheGreatRecovery's picture

Things that may be risky to trade:

 

anything leveraged

anything short, including vix

any options

Wed, 06/10/2015 - 20:07 | 6184134 chomu
chomu's picture

Old news wackos. VXX should be cantango'd sometime in the future to $0.00....but they will keep reverse splitting it to keep it alive. 

The steeper the forward VIX futures curve, the faster it will die. XIV is the opposite.

If you want to trade volatility, open a damn F&O acct.

 

 

Wed, 06/10/2015 - 22:06 | 6184955 JoWazzoo
JoWazzoo's picture

I tried VXX twice and lost my shirt.

 

FWIW, it hit a record 1 year low today,  BFTD :-)

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