This strategy falls under the VRP (Volatility Risk Premium) strategies class. Their main principle is to estimate the additional premium that option buyers pay for risk hedging. Most often, the comparison is between implied volatility and historical volatility or some other model. In normal situations, implied volatility is higher than historical, but the premium size can vary significantly.
The strategy was presented by Double-Digit Numerics in this workpaper. It compares the VIX value, which shows the 30-day implied volatility of the S&P 500, with the short-term (10 days) historical volatility of SPY. SPY, an ETF on the S&P 500, has a very high correlation with its underlying index. The very short period for determining historical volatility is presumably chosen to ensure a quick response to market changes.
To smooth the signal and avoid overly frequent trades, the obtained VRP value is averaged over the last 5 days.
Strategy Rules
Calculate VRP = VIX – (10 days volatility of SPY) * 100.
Average VRP over 5 days. Short VXX if averaged VRP > 0, long VXX if averaged VRP < 0.
Strategy Performance
Test period: 2010 – 15 Dec 2023. Costs (brokerage commissions, slippage and borrow cost) are not included.
| Averaged Strategy | Benchmark: Short VXX | Benchmark: SPY | |
| Full Return | 10 990% | 5 850% | 549% |
| Annualized return | 40% | 34% | 12.95% |
| Max DD | -74% | -92% | -34% |
| Sharpe ratio | 0.49 | 0.42 | 0.70 |
