/Introduction
The Market Volatility Strategy (MVS) is based on volatility as an anomaly for making abnormal returns in the stock market. It uses the VIX, often referred to as the "fear gauge" which measures the market's expectation of 30-day volatility based on S&P 500 index options, as it's measure of volatility.
/Design
The VIX term structure refers to the relationship between the volatility index (VIX) values across different expiration dates. The term structure is important because it provides insights into market sentiment, risk expectations, and potential volatility in the future. The VIX term structure can take on three main shapes:
1. Contango: This occurs when longer-term VIX futures are priced higher than shorter-term futures. It is the most common shape for the VIX term structure.
2. Backwardation: This occurs when shorter-term VIX futures are priced higher than longer-term futures, indicating that the market expects volatility to decrease over time. Backwardation is less common and is typically seen in periods of high market stress or volatility.
3. Flat: A flat term structure happens when the VIX futures are priced similarly across different expiration dates. This indicates that the market's expectations for volatility are consistent over time.
/Trading
The strategy uses an understanding of the VIX term structure to generate buy and sell signals, as it provides valuable information about future volatility expectations and potential risk.
- Buy Signal
Contango suggests that the market expects volatility to increase over time. In a contango environment, the strategy looks for long volatility trades.
- Sell Signal
Backwardation suggests that investors are concerned about the near term and are willing to pay more for immediate protection. In such scenarios, the strategy looks for short volatility trades.
- Cash
A flat term structure can be transitional, moving from contango to backwardation or vice versa, or it may occur when the market is uncertain about future volatility. The strategy is in cash in this environment.
/Signals
The strategy has three signals:
1) Volatility
2) Volatility+
3) Volatility*
This means a maximum of three positions, one for each signal, can be opened simultaneously to maximize gains from volatility.
/Results
The backtest results are based on a starting capital of $13,700 (convenient amount for retail traders) with 5% of equity for the position size and pyramiding of 3 to allow one open position at a time for each signal. Commissions vary from broker to broker and they are calculated in different ways so a simple but very high commission of $3 per order is used in backtesting this strategy. Slippage of 3 ticks is used to ensure the results are representative of real world, market order trading. Trades are generated on the close of the candle to avoid bias. The backtest results are available to view at the bottom of this page.
Note:
Past performance in backtesting does not guarantee future results. Broker execution, market changes and trader psychology can significantly affect strategy performance in live trading.
Originality:
The MVS strategy is unique because it is based on data from the futures and options markets. This is data that is not usually accessible or understood by the retail trader hence, volatility strategies are difficult for them to design. The strategy gives retail traders access to a volatility strategy with no parameters, this greatly reduces the risk of curve fitting while increasing robustness.
/Tickers
This strategy has been backtested primarily on SPXL but it is suitable for use on the VIX ETFs.
The Market Volatility Strategy (MVS) is based on volatility as an anomaly for making abnormal returns in the stock market. It uses the VIX, often referred to as the "fear gauge" which measures the market's expectation of 30-day volatility based on S&P 500 index options, as it's measure of volatility.
/Design
The VIX term structure refers to the relationship between the volatility index (VIX) values across different expiration dates. The term structure is important because it provides insights into market sentiment, risk expectations, and potential volatility in the future. The VIX term structure can take on three main shapes:
1. Contango: This occurs when longer-term VIX futures are priced higher than shorter-term futures. It is the most common shape for the VIX term structure.
2. Backwardation: This occurs when shorter-term VIX futures are priced higher than longer-term futures, indicating that the market expects volatility to decrease over time. Backwardation is less common and is typically seen in periods of high market stress or volatility.
3. Flat: A flat term structure happens when the VIX futures are priced similarly across different expiration dates. This indicates that the market's expectations for volatility are consistent over time.
/Trading
The strategy uses an understanding of the VIX term structure to generate buy and sell signals, as it provides valuable information about future volatility expectations and potential risk.
- Buy Signal
Contango suggests that the market expects volatility to increase over time. In a contango environment, the strategy looks for long volatility trades.
- Sell Signal
Backwardation suggests that investors are concerned about the near term and are willing to pay more for immediate protection. In such scenarios, the strategy looks for short volatility trades.
- Cash
A flat term structure can be transitional, moving from contango to backwardation or vice versa, or it may occur when the market is uncertain about future volatility. The strategy is in cash in this environment.
/Signals
The strategy has three signals:
1) Volatility
2) Volatility+
3) Volatility*
This means a maximum of three positions, one for each signal, can be opened simultaneously to maximize gains from volatility.
/Results
The backtest results are based on a starting capital of $13,700 (convenient amount for retail traders) with 5% of equity for the position size and pyramiding of 3 to allow one open position at a time for each signal. Commissions vary from broker to broker and they are calculated in different ways so a simple but very high commission of $3 per order is used in backtesting this strategy. Slippage of 3 ticks is used to ensure the results are representative of real world, market order trading. Trades are generated on the close of the candle to avoid bias. The backtest results are available to view at the bottom of this page.
Note:
Past performance in backtesting does not guarantee future results. Broker execution, market changes and trader psychology can significantly affect strategy performance in live trading.
Originality:
The MVS strategy is unique because it is based on data from the futures and options markets. This is data that is not usually accessible or understood by the retail trader hence, volatility strategies are difficult for them to design. The strategy gives retail traders access to a volatility strategy with no parameters, this greatly reduces the risk of curve fitting while increasing robustness.
/Tickers
This strategy has been backtested primarily on SPXL but it is suitable for use on the VIX ETFs.