VIX futures spend a majority of time in contango. This creates a positive tailwind for XIV, causing its price to trend up over time. This positive trend, however, does not come without large drawdowns from time-to-time. For example, XIV experienced a drawdown of over 70% in 2011. Drawdowns of this magnitude eliminate a buy and hold approach for most people.
A simple way to potentially outperform a buy and hold approach is to scale in/out of drawdowns in XIV. The idea is intuitive – if an asset is expected to trend up over time, the best time to buy is during troughs (effectively buying low).
Below are the results of following a simple process of increasing exposure to XIV as the level of drawdown increases, and adjusting that exposure back to the base-level once the drawdown in XIV is eliminated.
Note: no attempt was made to “optimize” the drawdown/scaling percentages
There are three key observations for the scaling strategy:
1) Drawdowns are less severe, including lower max drawdown (51% vs 74%)
2) Drawdowns are shorter in duration
3) Total return is higher (474% vs 281%)
It’s easy to see that scaling into drawdowns of XIV may give you a significant edge over a buy and hold approach. A scaling approach by itself, however, may still not be a viable strategy (max drawdown may still be too large).
However, if we combine information from the VIX futures curve (to determine the most opportune times to be long XIV) with a scaling in/out function, we may be able to significantly improve results compared to both buy and hold and scaling in/out approaches. Our Tactical Volatility Pro and XIV Yield Trader strategies attempts to do just that. Below are backtested results for these strategies since 2011:
While past performance does not guarantee futures results, it’s hard to ignore the potential power of a multidimensional strategy. We believe strategically altering exposure to take advantage of drawdowns in XIV gives us a significant advantage over a buy and hold approach, as well as most other volatility strategies that are purely signal based.
If you’d like to follow along with our Tactical Volatility Pro and XIV Yield Trader strategies, you can take advantage of our 7-day Free-Trial.