Q2 2016 Strategy Report - Volatility Trading Strategies

Just looking at the raw numbers, it looks like a very boring quarter.  Very few trades and the final result being just a small loss.  So nothing much happened right?  Well subscribers know there’s a little more to the story.  So let’s dissect this wacky quarter of trading because it illustrates a very important point to understand if you’re going to participate in volatility trading going forward.

The S&P 500 is not the VIX, and the VIX is not the S&P 500

Far too many traders try to equate the two and trade volatility products based on what they think is happening in the stock markets.  Now of course there is a long term correlation of about 82%, but that says little about the short term and nothing at all about the magnitude or causation.   The price action in June 2016 was a perfect example of this.

Chart of the S&P 500 for the 3 month quarter, highlighting those 2 days we suffered our losses:

Chart of the VIX for the 3 month quarter, highlighting those 2 days we suffered our losses:

The S&P 500 barely reacted, only rising 1.72% those two days.  The VIX on the other hand suffered a MASSIVE spike of 43.24%, which of course caused anybody holding volatility ETF’s to take substantial losses those two days.  In our case it took the nice profit we were sitting on for the previous 2 months and wiped them back to zero just like that.

Now obviously that really sucked, and the worst part about it was our Volatility Trading Strategy was just a fraction of a percent from exiting after the first day loss. The threshold was so close we nearly moved to cash, but I always trade the math down to two decimal places so we were in the trade.  Win some lose some right…

But there is a silver lining.  Because we get our signals from the volatility markets and not from the stock market or our gut feelings and future predictions, it also works in our favor many times as well.

Case in point, we were safely in cash the day of the shocking Brexit vote that saw the VIX spike 49% in a single day and destroyed the XIV ETF for a quick 26% single day loss.  Every other volatility trader I know was in the XIV that day and took the 26% 1-day loss.  And the S&P 500 signaled the exact opposite as well.  It was actually up quite a bit the day before, and a lot of people were front running the news and jumped right in front of the freight train.

The big take away is, you can never avoid the one or two day hits that occasionally come out of nowhere and ruin your day so if you’re going to be trading these products, just accept that it is going to happen from time to time.  Allocate accordingly.

To reduce drawdowns and increase diversification, we offer the Total Portfolio Solution.

But with industry leading risk management and capital preservation techniques we can be sure to reduce our drawdowns to the lowest amount possible.  It speaks volumes for our strategy that our largest drawdown ever was 22%, despite the fact that the XIV itself has dropped 26% in a single day and had a max drawdown of 71%.

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