As I mentioned last week here, I had found that the case against the VIX as a trading indicator was not so cut-and-dry. Earlier I had showed that trading stocks on the VIX using conventional wisdom- i.e. sell when the VIX is low and buy when it is high- was a losing strategy. However, this does not mean that VIX was unusable as a trading indicator. In fact, standardized VIX data can be used to trade stocks effectively, at least over the last twelve years, which is the time frame that I conducted the following study.
To perform this study, I standardized the VIX using the last six-months of trading data on a rolling daily basis. I established two break points in this study. The first states going long stocks- here the S&P 500 index- when the standardized VIX was equal to or below -1.25. The second break point I established was at the positive 0.50 level, where I would calculate a simulated short position in the S&P 500. The results of this study for the period between January 2000 and the present are shown below.
The pink line in the above graph shows the simulated portfolio going long when the standardized VIX was below -1.25, short for a standardized VIX above 0.5, and no exposure for those in between/transition periods. What this graph shows is that the simulated portfolio returned 145.5% versus 4.1% decline on the buy-and-hold S&P 500 since January 2000.
Just because a measure work historically does not necessarily mean it will work in a real-time trading environment. To that end, I am initiating a trading portfolio that will trade exclusively using the VIX-strategy I outlined. I will limit the investments in this portfolio to just three potential investments- a long S&P 500 ETF, short S&P 500 fund, and a long TIP ETF. I currently intend to use the Spider Trust (ticker SPY) for the long fund, the ProShares Short S&P 500 (ticker SH) for the short exposure, and the IShares Barclays TIPS 0-5 Year Fund (ticker STIP) for TIPS exposure. The later fund will be employed in those periods without a clear signal or transitional periods. Currently the indicator is showing no signal.
To perform this study, I standardized the VIX using the last six-months of trading data on a rolling daily basis. I established two break points in this study. The first states going long stocks- here the S&P 500 index- when the standardized VIX was equal to or below -1.25. The second break point I established was at the positive 0.50 level, where I would calculate a simulated short position in the S&P 500. The results of this study for the period between January 2000 and the present are shown below.
The pink line in the above graph shows the simulated portfolio going long when the standardized VIX was below -1.25, short for a standardized VIX above 0.5, and no exposure for those in between/transition periods. What this graph shows is that the simulated portfolio returned 145.5% versus 4.1% decline on the buy-and-hold S&P 500 since January 2000.
Just because a measure work historically does not necessarily mean it will work in a real-time trading environment. To that end, I am initiating a trading portfolio that will trade exclusively using the VIX-strategy I outlined. I will limit the investments in this portfolio to just three potential investments- a long S&P 500 ETF, short S&P 500 fund, and a long TIP ETF. I currently intend to use the Spider Trust (ticker SPY) for the long fund, the ProShares Short S&P 500 (ticker SH) for the short exposure, and the IShares Barclays TIPS 0-5 Year Fund (ticker STIP) for TIPS exposure. The later fund will be employed in those periods without a clear signal or transitional periods. Currently the indicator is showing no signal.
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