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Exploiting the Volatility Risk Premium with ETNs

Posted in Volatility Effects

"Identifying VXX/XIV Tendencies" finds that the Volatility Risk Premium (VRP), estimated as the difference between the current level of the S&P 500 implied volatility index (VIX) and the annualized standard deviation of S&P 500 Index daily returns over the previous 21 trading days (multiplying by the square root of 250 to annualize), may be a useful predictor of iPath S&P 500 VIX Short-term Futures ETN (VXX) and VelocityShares Daily Inverse VIX Short-term ETN (XIV) returns. Is there a way to exploit this predictive power? To investigate, we compare performance data for:

  1. XIV B&H - buying and holding XIV.
  2. XIV-Cash - holding XIV (cash) when prior-day roll when VRP is relatively high (low).
  3. XIV-VXX - holding XIV (VXX) when prior-day VRP is relatively high (low).

We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance statistics. Using daily closes for XIV, VXX, VIX and the S&P 500 Index from XIV inception (end of November 2010) through mid-November 2017, we find that:

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