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Why volatility? A primer.

Volatility as an asset class?

Volatility as an asset class has alpha advantages beyond any currently available to retail investors. It is readily tradable as exchange traded products (ETPs: both ETNs and ETFs are available), with high liquidity and very low spreads/low slippage. High-performing strategies are available that do not require shorting or option spreads or intraday trading, and can be calculated simply (by hand, or with an Excel spreadsheet).  Most importantly, it has fundamental tailwinds that drive a well-designed volatility strategy to significant gains. No other asset class readily available to mortals (retail investors) has such tailwinds.

Consider this a primer, explaining why trading volatility has advantages beyond the normal equities and index funds with which most retail investors are comfortable.

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MultiVol: preview of a new volatility strategy

MultiVol: A diversified approach to volatility trading

  • MultiVol trades XIV and VXX with a backtested CAGR of ~90% and Sharpe ratio > 1.0.
  • MultiVol stacks 12 different strategies to provide a diverse suite of volatility risk premium (VRP) signals with minimal optimization applied.
  • MultiVol can be used as a standalone strategy for IRAs or other accounts, or it may be utilized as a volatility-risk filter for other trading strategies.

MultiVol is a new strategy I’ve been working on for months.  I’ve been trading it live since mid-December, and it’s doing fine (up about 6% in a mixed market for vol).  MultiVol is a quantitive strategy for trading volatility ETPs (XIV, VXX) based on multiple VRP measures.  I calculate the VRP 12 different ways, and stay short vol (XIV) if NO signals are LONG, go to cash if 1-6 signals are LONG, and go long vol (VXX) when more than half (7+) of the VRP signals are LONG .  It’s a conservative approach (i.e., not many days are spent long vol), with a high daily win rate (near 60%) and backtested CAGR around 90%.

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Why invest in volatility? And what is roll yield anyway?

Why invest in volatility? Why should volatility be considered an “asset class” in the same vein as equities, bonds and commodities? What makes it different?

The short answer is: tailwinds.  The volatility funds have a unique driving force derived from the futures market that can propel volatility strategies in a way no equity fund could hope to achieve.  Roll yield and the volatility risk premium can be strategically harvested whether volatility is rising or falling, very profitably and with modest risk relative to the gains.  We’ll talk about roll yield in this post, and save VRP for later.

No other asset class available to retail investors has built in propellers that drive, on average, about 1/7 of the daily price movement in a predictable direction.  Remember the old Soapbox Derby racers kids could make and race in Akron Ohio (and still can)? And the scandal that erupted in 1973 when the winner was disqualified for secretly adding an electromagnet that gave him a boost at the starting line?  Well, that was cheating.  But volatility markets give volatility strategies the equivalent of a motor that drives profits (alright, and losses) at a remarkable clip, right past the other asset classes coasting along.  And it’s NOT cheating, it’s real and available to anyone.

Continue reading “Why invest in volatility? And what is roll yield anyway?”