Following our discussion of perhaps the most successful (and/or most risky) trades of the last decade - that of shorting the front-month VIX - we were less than surprised that VXX -the VIX ETF has collapsed to new record-lows this morning. A snap higher in VIX has been met by an avalanche of vol selling and, as we discuss below, the accelerating contango as expirations loom has encouraged yet more to take on unlimited risk positions to pick up pennies in front of the steamroller. All the time "The Fed has your back," it appears traders believe the steamroller driver has his foot on the brake... As if on cue - VIX has spiked and VXX surged.
Record lows for VXX - The VIX ETF..
and being short vol has been a big winner...
Especially the front-month as roll-down accelerates dramatically...
Killer Contango: The low-down on the roll-down VIX Weeklys: Understanding the front-end of the VIX futures curve.
We expect most of the VIX Weeklys flow to be traded one-month and in. Therefore, understanding how VIX futures move at the short-end of the curve will be critical for successful trading. We perform two simple studies to put historical moves on short-dated VIX futures in context: 1. Quantify the monthly gain on a short one-month VIX futures position. Said another way: How much does a 1m VIX future tend to roll down the curve due to contango? 2. Estimate the typical trading pattern of a VIX future over the final one- and two-weeks of trading. What proportion of the roll down happens over the final week?
Study Methodology: Enter a short 1m VIX futures position (nearby contract). The trade is held for one month and rolls T-1 business days prior to the next official VIX settlement date (Tuesday before Wednesday VIX settlement). For example, a short July VIX futures position would have been entered on June 16, 2015 (the last trading day before June settlement) and exited on July 21, 2015 (the last trading day of the July contract). Our numbers should tell us the profitability of passively selling a one-month VIX future. Our first position is entered in October 2005, when successive monthly futures contracts became available. We measure our P/L in vol points, for example, if the VIX future starts at 20 and drops to15 the short would make $5 per future traded (5 vol points). A few highlights:
The average monthly decline on the front-month VIX future has been 0.98 vol points back to 2005. Over the 117 months from November 2005-July 2015, selling a front-month VIX future was successful 70% of the time with an average monthly gain of $0.98 (median: $1.47) for a cumulative gain of $114.3. Profitability varied widely by year (Exhibit 5 above).
2015: The average monthly roll-downso far in 2015 has been 2.3 vol points or about 2.3x the long run average. Steep contango has led to strong performance on short VIX futures strategies so far in 2015. As mentioned above, the S&P 500 VIX Short-term Futures Daily Inverse Index (SPVXSPI), the benchmark index for ETPs such as the XIV and SVXY, is up 56% ytd. The last time rolls have been this high was in 2012 when the roll-down averaged 3 vol pts per month and the annual performance of the SPVXSPI was +162%.
70% of the profitability on a short VIX futures position has come over the last week of trading. A more granular analysis shows that the average decline in a one-month VIX future in the week leading into VIX settlement has been 0.68 vol points or 70% of the total one-month decline back to 2005. The average decline in the front month VIX future from ten days prior to VIX settlement to the last day of trading has been 0.46 vol points over our entire sample window. Caveat: While 70% of the VIX roll-down occurred over the last few days leading into settlement that number has varied widely by year and moving from five business days out to six or seven will change the numbers. We provide the average roll-down stats by year from T-2 to T-10 business days prior to VIX settlement in Exhibit 6.
2015: Large roll-down over the last week of trading. Of the average 2.3 vol point VIX futures monthly roll-down in 2015, 1 vol point (44%) of that has come over the last five days prior to settlement. Our point here is that the roll is heuristically similar to the theta of an option. A lot of the profitability on a short option trade can happen as the option speeds into expiration. In our example, the future converges lower to VIX spot.
But of course, as we noted previously, being short vol has been among the best performing trades of the last decade (never mind the risk-side) and, the introduction of weekly VIX futures (and the exponential decay implied by these volatility-inducing instruments) offers, according to Goldman Sachs, even more opportunity for active risk takers to sell vol, scrape premium, and face unlimited downside risk... playing the contango collapse game until there are no more musical chairs left.
As long as your pockets are inifnitely deep to cope with drawdowns like this...
Charts: Bloomberg and Goldman Sachs