I am introducing another element to my webpage/system next week. I've been wanting to incorporate XIV and VXX into my trading, but only when conditions are favorable. These are not leveraged vehicles, but since VIX can make some big daily moves, trading them can be rewarding. Not only are their prices affected by VIX movement, they are also at the mercy of the VIX futures structure...contango and backwardation. While I can't predict what the VIX will do on any given day, I can be aware of whether we are in a contango or backwardation environment.
A friendly warning, if you have a short attention span...skip to the conclusion! :-D
A long time follower pointed me to a website called vixcentral.com. On this page I was able to find the current and historical VIX futures structures. (Many thanks, btw!) With this data, I was able to identify periods of Contango, Strong Contango, Backwardation, and Strong Backwardation.
But first, we have to understand contango and backwardation and how they can affect XIV (and VXX). You can simply Google research contango and backwardation, but to shed some light on the interaction with XIV, Rob Hanna, founder of Quantifiable Edges and the newly introduced Overnight Edges, had this to say back in July...
“...but there is a 2nd factor that strongly influences XIV prices, and that is the VIX futures term structure. This is because XIV looks to maintain a constant-maturity short position. To do so it must buy to cover a certain number of front-month VIX futures each day and then short an offsetting amount of the 2nd month. When the 2nd month is priced above the front month that is referred to as “contango”. The stronger the contango, the more beneficial the term structure for XIV. To understand why this is beneficial consider tonight’s closing futures prices. July closed at $19.25 and August closed at $21.20. So XIV is buying at $19.25 today and selling at $21.10. Buying low and selling high like this can be quite beneficial to its value over the course of an entire month... ...the 10.1% spread between the front 2 months will have a positive influence on XIV’s price.”
Sounds good, but can a 1x leveraged XIV really compete with a 3x leveraged TNA? With contango on its side, you bet it can! Here are some tested results that I ran. First, during periods of strong contango.
Test 1: Buy TNA and XIV when VIX futures move to Strong Contango, sell when it exits to a different category. Starting amount: $10,000 each.
Final amount TNA: $12,023
Final amount XIV: $29,853
Results speak for themselves, wow!! XIV absolutely crushes TNA. (FYI: we are currently in a strong contango environment!)
Test 2: Ok, how about periods of (weak) contango. Again, starting at $10,000.
Final amount TNA: $11,966
Final amount XIV: $14,088
XIV wins again, but in a not so dramatic fashion. Still respectable!
Test 3: Backwardation (weak). Starting with $10,000.
Final amount TNA: $7331
Final amount XIV: $5754
XIV loses, as one might expect. However, let's pit TZA up against VXX during Backwardation...
Final amount TZA: $11,500
Final amount VXX: $14,122
And for fun...Let's let UVXY (2x VIX) in on the action.
Final amount UVXY: $10,456 (decay kept it from beating its 1x counterpart)
So during backwardation, it appears VXX beats TZA and UVXY. I should mention that UVXY hasn't been around a long time so it's not a very fair comparison. I am still going to avoid using it... Too dangerous for me.
Test 4: Strong Backwardation. This environment doesn't happen very often. And often after a prolonged period of strong contango, if we dip into strong backwardation, it's a great BUY (TNA) signal!
Final amount TNA: $9196
Final amount XIV: $6003
Final amount VXX: $12,935
Final amount TZA: $6354
UVXY - Not enough data.
With strong backwardation (which usually accompanies a downtrending stock market) we see VXX destroyed the decay-happy TZA.
When we are in a contango environment, I will favor XIV over TNA for any long signals. Short signals will continue to utilize TZA.
During backwardation, I will favor VXX over TZA for any short signals. But will continue to use TNA for buy signals. I will not touch XIV during backwardation, nor will I touch VXX during contango. And, I will never touch UVXY during either backwardation or contango. :)
I will update the webpage to list which VIX futures structure we are in (currently "strong contango") and will also display the 2 ETF's I will be favoring for system trades. Currently XIV (long signals) and TZA (short signals).
There is more work to be done, although I won't get to it anytime in the near future. Someday I will plug in this new configuration into my system and run some tests using TNA/TZA/XIV/VXX rather than just the TNA/TZA. I shudder to think how much work this will be! Lol. Additionally, I can see myself updating the webpage to track stats using all 4 ETF's but for now will just keep it simple tracking just TNA.
Here is what the current strong contango VIX futures structure chart looks like. (From vixcentral.com)
And backwardation from last August. VXX would benefit substantially over TZA. Likewise, TNA beats XIV for long/buy signals.
Thanks for reading.... have a great Labor Day!