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Shorting VXX with Crash Protection

Posted in Volatility Effects

Does shorting the iPath S&P 500 VIX Short-Term Futures ETN (VXX) with crash protection (to capture the equity volatility risk premium safely) work? To investigate, we apply crash protection rules to three VXX shorting scenarios:

  1. Let It Ride - shorting an initial amount of VXX and letting this position ride indefinitely.
  2. Fixed Reset - shorting a fixed amount of VXX and continually resetting this fixed position (so the short position does not become very small or very large).
  3. Gain/Loss Adjusted - shorting an initial amount of VXX and adjusting the size of the short position according to periodic gains/losses.

We consider two simple monthly crash protection rules based on the assumption that volatility changes are somewhat persistent, as follows:

  • Prior Month Positive Rule - short VXX (go to cash) when the prior-month short VXX return is positive (negative).
  • Prior Week Positive Rule - short VXX (go to cash) when the prior-week short VXX return is positive (negative).

For tractability, we ignore trading frictions, costs of shorting and return on retained cash from shorting gains. Using monthly closes for the S&P 500 Volatility Index (VIX) and monthly and weekly reverse split-adjusted closing prices for VXX from February 2009 through early February 2018 (110 months), we find that:

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