In response to this question:
Hi jrv, on the topic of permanently shorting VXX I just started shorting UVXY by selling front month call spreads on any VIX spikelettes. I too expect this trade to benefit from decay due to daily rebalancing as well as contango on the way down and probably underperformance if the way turns up as well. Because the trade is net short on volatility I also expect it to benefit from typical overpricing of options on leveraged ETFs. The key drawback I see is that UVXY is currently less liquid. What might be other drawbacks of doing this trade versus shorting VXX?
(source was taken from this comment)
I answered what is written below. It is something which I have little experience with so feel free to give feedback if this is something you have done or know about.
Makes sense to me Nick, all that you say, I might do some spreads myself some day. I did look into it not long ago because I’ve heard about strategies of people doing it with the VXX. They sell a spread periodically (1 per week) and have some rules to either close them or hold them to maturity. There is one nice guy who says he has been making a lot each month selling VXX put spreads, he’s on VXX’s yahoo message board and is very nice, he goes by the name of slcehamrick but is referred to as Rick. He explained very specifically what he does. Check below for details. Or you can ask him more detail, but its quite clear already, he’s very open about it and accessible. That is why I though about spread strategies.
In reply to con_law_misery‘s question:
Rick could you shed some light on how exactly you make 7% per month on VXX and what percentage of your portfolio you use to employ this strategy? Surely you don’t make 7% on your whole account every month?!
No problem and, no I am way too chicken to make 7% per month.
Each week (Monday, not right at the open but usually in the morning) I put 1% of my total portfolio in a VXX put spread 4-6 weeks from expiration, buying the closest strike to the money and selling the strike that I believe will not be reached based on my weekly analysis of (1) contango, (2) negative roll yield, and (3) mean reversion potential. Usually this means I am selling a strike 10-20% below the strike I bought. I hold the position for no more than five weeks or expiration, whichever comes first.
I close ALL open put spreads when either (1) the 20 day sma cash VIX (NOT VXX, the cash VIX) is above the 60 sma cash VIX OR (2) if the front two months backwardate. I will also close an INDIVIDUAL open put spread when VXX reaches the lower strike (this is because I can’t stand losing profits I have already mentally banked!)
As an example, on July 9 I bought an August 14/12 put spread for $.92. I almost went with 13/11 but oh well. Anyway the spread is currently worth $1.33 so on that particular week’s trade I am up 45% on the $.92 I risked.
I am a major trading chicken so I have many built in protections. First, by investing (okay, gambling) only 1% per week I never have more than 6% of my portfolio in these spreads at any one time. Two, because I am long spreads, not short, I know my max loss.
Of course, my approach has negative theta, which many people would see as a drawback.
This Monday it looks like I will probably buy a 13/11 August spread. BTW, there is a very good chance I will lose money on this one because the 60 dma for ^VIX is down to a little over 19 so it wouldn’t take much of a ^VIX spike to generate a sell signal.
Hope that helps. It sounds complicated but only takes me 15-20 minutes each day to monitor and I average about $8000 per month profit with what I am risking.
source: yahoo vxx message board
He did it until now from all the way down, which gave good results (excellent) but who knows what his performance would have been in other conditions, with flat or increasing VXX, it could be harder. A very nice guy and very very clear in how he did it. The rules he applied etc… It all made sense but since I did not back test it I can not tell you how it would perform. I tend to think that its not easy to win anyways, the losing trades might not offset the winners. But he did it, actually many shorts have been wining in all the way down from 45 to now. The thing is how would they perform when VXX triples and that will happen for sure it could happen now or from 3 to 9, who knows but it will happen. It’s not contradictory with the fact that it tends to 0. While converging two 0 the VXX has been having spikes of 2 to 5 times on several occasions. So you need to manage the risk of shorting before one of them. I do it by shorting little and only if the volatility is high and backwardation clearly falling, among other conditions. So even if I am wrong, which I could be, since it’s a little amount I wait it out because the amount even if multiplies several times will not cause margin calls and I am sure on the long term I’ll win anyways. So my strategy is not based so much on prediction as on the fact that the product is designed to go to 0.
Liquidity is indeed a disadvantage of the UVXY, and specially if it gets worse when volatility increases, it could increase a lot more the bid/ask spreads and multiply the problem. I don’t see other problem for now but I am not familiar with the ETF you use.
But yes applying your strategy to VXX seems very interesting. Specially since you limit you losses if things turn bad. By just plain shorting, I don’t limit losses, that’s why I keep the short small. But one thing I’m sure is that a plain short will eventually turn out good, that’s why I like to simply short a small amount. So if I short 3%/year of my portfolio I can make (on average) 1.5%/year additional return on my portfolio, with no risk, not worries of margin calls etc. I see it as a free ride. And 1.5% additional return is a lot more (for example instead of 8%/year return make 9.5%/year, that’s not bad!). I would only lose if VXX is multiplied by 30, and that’s unlikely .
But spreads are different because you have the time issue, they expire and you either win or lose on every time. The strategy is different. So the thing to be sure about is if all your winning trades compensate the losers on different market scenarios. So yes that’s the think to check but you should know much more than me. It does really look interesting though. Regarding your question I do not see any disadvantage besides the lack of liquidity you mention so in that sense I think it should work nice with VXX.
Bye Max and congratulations because on pre-market UVXY is like 7% down!
Good luck and keep me informed if you like, always a pleasure .