Thoughts about using VXX or UVXY spreads as a short volatility strategy to benefit from contango

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?!

Rick replied:

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 .

About jrv

I was born in Spain and lived in Belgium, Chile, France, USA, Argentina among other places. Currently I am trying to settle down in a wild place. I am "retired", even though now I dedicate more hours "working" for my investments than I ever worked in the real labor market where I used to work in IT and Banking. I am a family man, I have a lovely wife, several sons and one step daughter. I have humble tastes, I like to stay home and read about companies and investments. I started investing at 25 before the internet bubble exploded. I did not know much about investing and liked technical analysis so my results were pretty bad. Fortunately I did not have much to lose. Some years later in 2006 bored of doing only real state investments and with quite a lot of money saved I opened an account in a cheap and excellent online broker and started again. This time I did not want to commit the same mistake, so I decided to follow a model. I heard that Warren Buffett was the best at making money via stocks so I started by reading a lot about him, all of his shareholders letters and several of the books that he recommended. I learned a lot, started applying his investing principles and reading a lot of 10K's. Digested news from lots of different sources. Basically I started buying very good and cheap companies and holding them for ever if possible and if nothing changed fundamentally. When the housing crisis started I was more than 75% cash. At that time I identified good companies at incredibly cheap prices so I invested most of my savings in stocks. In less than I year I doubled. By the second semester of 2009 I turned my software company into an investment vehicle and dedicated myself full time to it. My wife and I decided to change our lifestyle and moved from Belgium to the beach in a wild country. The goal was to keep fixed costs low in order to be able to live with a minimum 6-8% yearly return but specially to move away from the inhuman life of civilization and to have finally some peace and sunny weather to concentrate better on investing. Now I can think and study about companies 60 hours a week and I am doing great. I can finally do what I want full time and can proudly say that I have never been so happy, specially also with my just born 4th son, my other great kids and my sweet wife who supports me fully while I study most of the day and patiently wait for the opportunity to make a swing ! You can learn a bit more about my portfolio by viewing it at or you may learn more about me and my family by following the link "Author's site" from the menu above.
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16 Responses to Thoughts about using VXX or UVXY spreads as a short volatility strategy to benefit from contango

  1. max says:

    Hi jrv, thanks for the response and interesting link. Over the past week shorting UVXY call spread (aug call strikes 9-8 for $0.46) has clearly been a better choice than shorting VXX, so far so good.

    As you point out the key challenge when trading monthly spreads is disciplined money management. I now maintain a 90% cushion when opening the trade. To not be overly aggressive or defensive I require a risk/reward ratio between 100% and 120% and contango at ~96% or less. I require an entry point at the top of the inter day trading range and – if needed – close only at the bottom. Meet this requirement can take some patience and there is a risk of missing entry altogether, so I have learnt to decisively pull the trigger on any opportunities that meet the criteria. If the trading range shifts against the position I apply the same rules to roll the trade. At some point VXX will spike violently into backwardation so the position cannot be rolled. Since I have never been able to trade backwardation profitably I won’t try anymore. Instead I will incur the limited loss and wait until the tide turns and it’s safe to swim again. One aspect of money management I am struggling with is how best to manage the (>80%) cash portfolio. To minimize Forex exposure I divide equal parts Euro, Dollars and Yen but I’m unsure this is even the right approach to managing cash. As always I appreciate your thoughts. All the best! Max

  2. jrv says:

    Oi max !

    You are selling calls 8 and buying calls 9 ?

    As I understand the strategy requires having a lot of cash on the sidelines, specifically between 80 and 90%.

    If I was in the position where I had a profitable strategy and I could nicely profit but it required me to have a lot of cash on the sidelines then I would make sure that the cash was very easily available for the time I need it. I would definitely not put it on stocks nor bonds since they could fall anytime, or worse, just when you need them. I would not stay in a single currency. I would select 4 or 5 strong currencies, more or less equally divided, among the following:

    1) Euros from Germany or the Netherlands (not from Spain or Italy). So that if the Euro disappears they would be transformed to a strong currency probably. But since I’m not sure I would not overweight.
    2) Yens
    3) Canadian dollars
    4) Krones from Norway
    5) Dollars (would not overweight neither, I don’t trust much their value).
    6) Australian dollars
    7) Swiss Francs
    8) Even a bit of Chilean pesos would not bother me (strong country, negative inflation now).

    If I could, I would put them in very short term deposits with different expiry dates each so that the money would always be available. If not I would just leave them in some sort of savings account or money market, where it would immediately be available.

    But I would require that strategy to at least double the 10% used to compensate for the inactive 90% and the currency risk. That would mean that I would require to earn at least 10% (90%+2×10%) a year.

    Anything smaller than that I would prefer to do other things because my opportunity cost is around 10%.

    Actually I like your strategy, if you are willing to spend time on it, in the sense that it allows you to earn money on normal times and leaves a lot of cash to use in very bad times, when backwardation is present. In bad times, like crashes and extreme high volatile periods your strategy becomes worthless, you will stop it altogether, but then you can use that cash when cash is king and few have it. You could deploy it on stocks which by that time many would be trading at cheap levels and therefore should not be difficult to find.


  3. jrv says:

    Post Data

    You can also do an equivalent strategy, kind of a mirror of what you do:

    Using a put spread with the XIV.

    Selling a put strike a bit lower of the current price and buying a put with the strike immediately below the one you sold to hedge it. Apply the same logic to close it or roll it. Worth considering.

  4. max says:

    jrv, thanks for the advice on cash management, I do like your suggestion of holding francs, krones and pesos. Trading with contango can yield up to 10% monthly, on yearly basis >10% is definitely expected. I have looked into bull spreads on XIV and SVXY but I am hesitant because these inverse ETFs add path dependency risk that seems impossible to manage. For example between Dec 27 and Mar 22 XIV and SVXY were up 70% and VXX was down only 46%; while between Mar 26 and Aug 1st VXX was down 22% and XIV and SVXY were both flat -0.1%. UVXY also has path dependency but I don’t think this gets in harm’s way directionally. What is great about SVXY is it’s trading in the 90′s allowing more precise positioning of the spreads, I hope the UVXY and VXX reverse splits happen soon.

  5. jrv says:

    Yes those path risks are very annoying indeed.

    Last time that the VXX reverse split on mid November 2010 at around 11. It should therefore reach that value if they split like last time.

    If contango stays at around 10% and volatility stays as it is now we should see the VXX falling to that value in 2 months. Hope they do a 8:1 reverse split this time :).


  6. max says:

    Hey jrv – it was good to be massively short VXX today, worth the 2 week wait :-)

    I sold much of USD/NOK today on a sense that USD and EUR will be headed lower the coming months. What do you think?


  7. jrv says:

    Hi Max, yep contango is quite high, I’m holding a few “old” vxx shorts indefinitely or until the weighted average of the 2 first vix futures reach a low value that would make me uncomfortable, but since it is not the case I let contango do its job.

    I don’t feel comfortable holding dollars, I have even been shorting them, but besides that I don’t really know about currencies.


  8. Kainvest says:

    There is no option on XIV, right?

  9. jrv says:

    Hi Kai, No options are available for the XIV.

    If you plan to short the VXX, going long XIV is an alternative that many prefer to follow because they do not risk of losing more than what they invested. So in that sense you do not need to use options to protect yourself.


  10. Kainvest says:

    What is “path dependency risk”?

    I can guess it out. But would like to know what caused it and how to mitigate it? Thanks.

  11. jrv says:

    I guess that comment is because of the fact that the path followed by the VXX is not the same as the one followed by the XIV. For example if the VXX in a given period goes from A to B and then back to A you might expect the XIV to do something like going from A’ to B’ and then back to A’. But that does not happen because of the way the XIV is constructed which is simply a daily inverse of the VXX in the sense that if the VXX changes X% in a given day the XIV changes -X%. But that property does not happen in more than one day. More info on the subject is found here:

    If you know how the XIV is modeled based on the VXX and how it has performed historically you can take a better and informed decision on how to use it.


  12. never mind says:

    I’m from the same boat. I was in SAP. I was hating it. 7 years of imprisonment into something that I disliked doing. Lol. I hope I make it. I’ll try hard not to screw up. This is too good an opportunity to live on my own to let it go…Glad that I found people from the same boat!

  13. jrv says:

    Really hope you make it, feel free to keep contact.


  14. ps470007 says:

    So, my prediction 2013- Good companies in the general economic environment with Smart Management will give you back $$$. 2013 and beyond. No matter what the state of the economy is! Sooner or later! Fish the winners! Its like you fish different types of fish in different season of the year- you buy stocks according to the economic psychology of wall street and sell them accordingly. I think its also a good idea to look after growth stocks- lot of day traders jump in at earnings..and then leave for another one..while if you can understand the difference between sudden increase after a positive earning and then sudden drop (day traders parting); however, next earning will be even better..i think these are cigar butt incidents..where you can jump in and just WAIT!

  15. jrv says:

    If I had to make a guess I would say that with the huge amount of US debt and the governments dependency on companies stocks must go up and common workers real incomes go down.

    That’s because the debt is huge and must be paid by companies and common citizens. For common citizens its easy to make them pay, the government either taxes them or prints money, in either case or a combination of both they are transferring money to the government.

    For the case of companies the government can not suffocate them because otherwise they will receive less by choking their profits. Therefore the government does everything possible to create an environment where companies are able to pay them well. The best environment is when they are internationally competitive and have big benefits.

    In simple words, money is transferred to the government or companies from common workers. So the best place to keep money is invested and certainly not too much cash due to the low interest rates and treasury bond bubble. That combined with quality and strong balance sheet of US companies makes me think they have still a lot of potential to keep growing.


  16. jrv says:

    Hi ps470007,

    I just created a post originally inspired to tell you what my guess is about the US stock market:

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