I am immediately starting to get feedback from readers with the results of the analysis of the historical VXX data available here. What was obviously missing was a relation between the VIX (blue, right axis) and the VXX (purple, left axis), we can now clearly see it thanks to a fellow investor friend mine:
Look at the graph:
2004/5/6 – the vix is moving in a 10-20 range and contango is killing the vxx
2007 – volatility is picking up from 10 to 30, contango is keeping the vxx flat
2008 – the highest vix spike ever (80) quadruples the vxx, but contango erases all of the impact in less than two years
If you have time on your side, you can handle any vxx spike, the trick is to never let a vxx short position become more than 5-10% of your portfolio (5% when you first short and 10% when the market bottoms) so that you can handle an increase by a factor of 10 without margin calls
If you have more interesting observations like this please let me know.