Schaeffer's Trading Floor Blog

Reading the VXX Tea Leaves After a Volatility Spike

Gauging VXX reactions to an 'overbought' VIX

by 1/28/2014 7:22 AM
Stocks quoted in this article:

I'm always looking at SPDR S&P 500 ETF Trust (NYSEARCA:SPY) returns when the CBOE Volatility Index (INDEXCBOE:VIX) makes certain moves…usually abrupt up moves. So, I figured I'd change it up a little bit. What happens to the iPath S&P 500 VIX Short-Term Futures ETN (VXX) when VIX closes greater than 20% above its 10-day simple moving average?

But first we have to put everything in context. VXX is historically awful to own. It's down over 99% in the five years since it first graced our trading screens. When I look at SPY, I usually go out three and/or six months. For VXX, we're just going to look at holding periods of five trading days, 15 trading days, and 25 trading days. You really shouldn't hold it for longer than a week at any time, but we'll extend it out for these purposes.

Here's the deal: This system will buy VXX on the close of the first day that VIX closes 20% above its 10-day simple moving average. It will close the position after five trading days, 15 trading days, or 25 trading days. It will not overlap holdings (i.e. -- if VIX triggers the system twice within five weeks, it will only look at the first instance, et al.).

Table of VXX after notable VIX upswings

There were 15 prior instances over the last five years. At the bottom of the table you can see the average returns of each holding period, as well as the average returns of buying VXX on any random date and holding for five, 15, or 25 trading days.

The first conclusion is not to ever own VXX -- all the results are bad. Then again, I hope you knew that already.

The second conclusion is somewhat interesting. Buying VXX when VIX got overbought actually outperforms the random VXX purchase modestly in the 15- and 25-day windows. Of course, "outperform" is all relative. VXX still worked poorly, it just did less poorly than it normally does. And that rule doesn't extend to the five-day holding period, as you actually do notably worse.

That suggests a common pattern. VIX overshoots the station, leading VXX to overreact. The market settles in, but remains (relatively) under pressure over the course of the month. Or, at least the perception that the market is under pressure remains. My personal opinion is that the echoes of these VIX pops linger for a bit even if the market itself stabilizes. And as we noted last week, there is evidence that the market itself stabilizes over the course of a month.

Frankly, the results are skewed a bit by a couple of huge gains in VXX, as you can see in the table. It's still a very small sample size, but here's my grand conclusion: It's very likely VXX will underperform even its ugly self if you jump in right after VIX has already popped. But every once in a while, shorting VXX into a VIX pop will turn into an absolute disaster.

And, of course, we'll only know how this current VIX plays out with the benefit of hindsight.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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