The blogosphere is a very interesting microcosm of the trading world. Many of my older readers will no doubt remember the glory days of “short-term mean-reversion”. By which I mean of course the multitude of posts (including several from yours truly), about RSI2, DV2 and the like. Around 2010 this type of strategy was quite successful and many people put their twist on it posting their results.
Then while this humble publication went into hibernation the collective brain trust of the community turned to the relatively new volatility ETF space. It was glorious; backtests were run, strategies were tweaked, whole websites tracking the strategies popped up and simulated equity curves went to the moon. Life was great. Then on Monday 2018-02-05 the music didn’t just slow down, it stopped. $XIV, the workhorse of many such strategies, there is no nice way to say this; blew up. From what I can see, its demise was met with mixed emotions. Twitter traders with $0.00 AUM knew it all along and were obviously already short $XIV from the high for size. People with subscription strategies either patted themselves on the back for side-stepping the reaper this time, or went AWOL to avoid having to take ownership for the losses incurred by their subscribers. My personal favorite are people selling strategies that usually held $XIV shares as their de-factor short-volatility security declaring that its demise is a non-issue; $UVXY will do the trick just as well!
This demonstrate such a blatant lack of trading IQ I struggle to put into words. The idea that because it was side-stepped this time the next face-ripping event will as well is simply preposterous. Selling volatility is something you do with other people’s money. It’s a great business, you pocket the recurring fees and performance incentives and when the music stop and you lose your client’s money they take all the loss. As Ron burgundy would put it, 60% of the time, it works every time. We would all be so lucky to find such asymmetric payoff propositions for ourselves, I share in the wins now, you get the blowout later, thanks for playing.
The vast majority of such systems I have encountered in the blogosphere were based on term structure signals to determine whether long or short volatility exposure has tailwind. In this particular instance, thankfully for some, the signal to get out of the short happened before the spike. Why should it do that next time, or the time after that?
I’d love to hear your thinking on the subject, esteemed reader. I know short volatility is a popular trade and has been for some time. Are you still going to do it? Are you worried about events such as the one form this past couple days being an issue in the future? Do you want to pay me a monthly fee for putting you in a trade that has an expected value of 0?
I would be down with that if I could sleep at night knowing you take all the risk and I will be the only one left with any profits to show for when the chips land at the end. Unfortunately, I could not live with myself. For those interested, you can look on collective2 but make sure you filter the strategies by performance excluding this week.