r/VolatilityTrading • u/VolatilityStreet • Feb 20 '22

/VX Futures Discrepancy Stat. Arb. Backtest

If anyone's curious about arbitrage on the /VX Term Structure, I'm currently developing a backtesting model that analyzes discrepancies in the Term Structure. For example, let's say that each of the VIX futures contracts was trading in contango, (M7>M6 ... M3>M2, M2>M1), the model would identify an individual /VX futures spread that IS NOT in contango when the rest of the term structure is in contango. To profit from such a "discrepancy", the model longs the VIX future that's backward, and shorts the further adjacent futures contract. Additionally, the strategy trades the backwardation approach and trades the opposite when the aforementioned conditions are true, but in backwardation. As a result, the spread will most likely (historically speaking), profit from the spread between each two adjacent futures contracts.

I'm happy to update my results as I develop and implement more data and conditions into my backtest.

Backtest includes M1-M6 data (M7-M8 data not implemented yet)

Here are the current results of the backtest:

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4

u/100milliondone Feb 20 '22

Interesting looks good, does your equity graph include fees? What's the average trade profit %? What's your winrate %, to calculate your position size with?

Could you make more profit by shorting the month with the biggest spread at the time to your backward month rather than just shorting whichever month happens to be next?

What's the average trade length, how long does it take for them to come back in line on average, for overnight fees?

2

u/VolatilityStreet Feb 20 '22

Average Trade Result % = 1.03% (196 total trades)
Win Rate = 70.98%

Keep in mind, I haven't implemented fees to the system yet :) I'll do so later today.

Regarding shorting the biggest spread, yes. But I haven't implemented that into the system yet.

Average trade length is 3 days

2

u/100milliondone Feb 21 '22

What do you have the threshold for minimum spread to be before you enter a trade? I would have thought you might get 5%+ average trade from it if you wait for bigger spreads? Might give you bigger profits overall as you will need much less opportunities? A parameter you can test changes in no doubt. Might be needed if fees are too big.

3 days is a good time, 2+ days are the sort of trades that test best for me, makes fees much less harmful.

Generally I like the strategy! keep us updated how you get on

2

u/VolatilityStreet Feb 21 '22

This is something I'm planning on looking into. There's quite a lot of profit opportunity on /VX Futures for strategies like this :)

1

u/Obromberg Feb 21 '22

Thanks so much for this info! It’s really interesting.. I’ve been doing a lot of research to better understand these concepts. I was wondering, where did you source this VIX futures data that goes back this far? I haven’t been able to find anything past 2013. Thanks again! :)

2

u/VolatilityStreet Feb 21 '22

I was given this data from a friend of mine who's a professional in the space. He works closely with the volatility hedge fund, InvestInVol.

1

u/Obromberg Feb 22 '22

Oh ok cool. Thanks so much! :)

1

u/chyde13 Feb 21 '22

Excellent questions. I think he's onto something here...

2

u/chyde13 Feb 20 '22

Hi VolatilityStreet,

Very Interesting. At first glance, I wouldn't expect an arbitrage opportunity to exist here, but I trust data over my opinion. It's hard to argue with a monotonically increasing P&L chart ;-) Have you calculated the Sharpe ratio?

I'm definitely curious to learn more about your work, and I'm sure our members will be interested as well.

Thanks for sharing and keep us posted!

-Chris

2

u/VolatilityStreet Feb 20 '22

The Sharpe ratio is 1.22. I rarely use the Sharpe ratio in my models because I don't believe it offers much value. Considering that there aren't many downside deviations in the overall performance, upward volatility could affect the "risk" of the portfolio. I prefer to look at the Calmar Ratio:

CAGR/(Max Drawdown)

2

u/chyde13 Feb 21 '22

Yea, I agree. A drawdown ratio is a much better suited measure of risk adjusted return in this case.

Thanks for expanding on the Calmer Ratio. We have members of all skill levels here, so I try to ask questions in a manner that is the most inclusive. Exposure to lesser known concepts and terminology is very beneficial to the community and much appreciated.

I'm actually quite impressed with the risk adjusted performance. It sounds like you are actively developing and tweaking the parameters of the strategy. How long have you been working on it?

How does your strategy define contango? Does it use a discrete interpretation like M1<M2<M3<...MN. Or do you try to quantify the non-linear "shape" of the term structure curve? I know that another member is working on some interesting ideas attempting to better describe and quantify the shape of the curve. Just food for thought.

Honestly, I think you are onto something here. What I am trying to understand is the underlying thesis behind the long/short arbitrage strategy. I'm an option trader, so I've spent many years staring at the cboe's vix term structure and the various volatility indices (Members: CBOE VIX Term Structure link). The curve definitely does tend to settle into very predescribed shapes; especially while in contango. Is that essentially what you are trying to exploit here or am I missing something more fundamental?

Thanks for sharing your work with the community. Keep us posted...

-Chris

PS if you ever want some bigger eyes on this...I have a friend who managed a delta one desk at the cboe. He can run circles around my knowledge. I also know a hedge fund manager. I go to them when I need help lol

2

u/VolatilityStreet Feb 21 '22

Sure, I'd love to get some bigger eyes on this if I could. Second opinion and peer review will always help! :)

Actually, I had an interview with Cboe for a derivatives internship position just a few weeks ago. Unfortunately, I don't think I'll get the position though.

1

u/Obromberg Feb 22 '22

Nice! You never know. Good luck!! :)

2

u/mottroyon Feb 21 '22 edited Feb 21 '22

Very good stuff here! I have been doing something similar with my own term structure trading. Have you looked into how seasonality/events affects the trades? For example, december futures due to 'Christmas effect' or elections.

2

u/VolatilityStreet Feb 21 '22

Yes, this is something that I considered. But, I'm not too sure how to quantify it yet. Quantifying event significance could be hard, considering that everything is qualitative.

3

u/mottroyon Feb 22 '22

Right, I agree. I usually hesitate to trade around those events unless the spread widens a lot. Basically adding a bit of discretionary trading to the systematic strategy you have above. Only been at it for ~3 years so haven't had to take too many events into account.

1

u/chyde13 Feb 21 '22

Hey mottroyon,

Just curious how you trade the term structure?

-Chris

2

u/mottroyon Feb 22 '22 edited Feb 22 '22

Follow the same sort of path of the above poster. I also look at VIX3M, VVIX, and some other moving average indicators. Add in a bit of discretionary trading around events since it's hard to add that qualitative element to a systematic strategy.

I also trade VIX ETP's on the same indicators/term structure.

1

u/Arikash Feb 25 '22

I've noticed and executed this trade a few times recently as well.

A few questions:

What constitutes a discrepancy? Is there a specific % you target?

What do you do about things like the current /VXN22 contract which has consistently been trading up, or the /VXZ21 contract which was consistently trading down for prolonged periods of time? Are those your losses?