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| Type | Master's Thesis |
| Scope | Discipline-based scholarship |
| Title | Combining VIX Futures and Options to Enhance Performance |
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| Institution | University of Zurich |
| Faculty | Faculty of Business, Economics and Informatics |
| Number of Pages | 31 |
| Date | 2020 |
| Zusammenfassung | This study elaborates on the performance of short VIX strategies, using futures, op-tions, and combinations of the two. There is extensive research on how to price VIX futures and options, on the potential benefits of long VIX investments to diversify stock portfolios, and on the efficiency of the VIX derivatives market. However, to the best knowledge of the author, there is a lack of academic research on short strategies. Furthermore, existing research primarily focuses on VIX futures leaving out VIX options. For this analysis, the longest possible data set is utilized, spanning from November 2006 to August 2019. Daily price data for VIX future with different maturities, ranging from short- to long-term and short-term out of the money VIX options is downloaded from Bloomberg. A special focus is given to realistic assumptions, with a strong focus on investability and inclusion of trading costs. The S&P 500 total return index and the Bloomberg Barclays US Aggregate Bond Index are used to compare the long-term performance of the strategies with traditional asset classes. The conclusions from simple short strategies, where future contracts are rolled on a monthly basis are the following: it is crucial for any strategy to be daily rebalanced as infrequent rebalancing can lead to significant divergence of initial exposure translating into a high volatility and high daily losses. Strategies with daily rebalancing exhibit different behaviors, depending on the maturity of the future contract and the exposure chosen. While strategies with high exposures at the front-end of the term structure do not survive, strategies with longer-term futures show negative to very low returns when accounting for spreads. The best strategies are those with low exposure using the front-month future. However, they are still inferior compared to the S&P 500 and exhibit a high correlation with the latter. Given this results it can be questioned why investors would short VIX futures. It is found that simple short VIX future strategies most likely appeal to investors because they can yield high returns over an optimal time horizon: over a chosen period of a little less than 10 years, a simple short strategy with the front-month future gained almost 30 fold the starting investment, including trading costs. Shortly after, however, the value would have dropped to zero in only one day. In a next step, this study tests if the predictive power of the VIX future basis, defined as the price of the future minus the VIX, mentioned by Alexander and Korovilas (2012b) and Simon and Campasano (2014) can be implemented to improve simple short strate-gies. Simon and Campasano (2014) suggest shorting VIX futures when the basis is positive and buying them when it is negative. This strategy improves the results across the term structure. Additionally, it is found that this strategy can further be improved by only shorting VIX futures when the basis is positive and invest in cash when it is negative. However, when testing for the stability of the signal over time, it is concluded that the predictive power of the basis has vanished over time and no statistically significant return improvement can be found in recent data. Therefore, evidence for the increasing eÿciency of the VIX future market is found. Trying to capture the "short VIX premium" utilizing an option writing strategy with out of the money call options proves to be even less successful than short VIX future strategies. Regardless of the exposure or moneyness deployed, all strategies exhibit negative returns. The bad performance can be explained by the very large spreads in the VIX option market and hence, it is concluded that any strategy with VIX options will be significantly hurt by trading costs. Finally, combination strategies using VIX futures and options are analyzed, whereby VIX futures are sold and out of the money VIX call options are bought to protect the downside. The backtest shows that VIX calls successfully lower the volatility and the maximum daily loss of short VIX future strategies but are too costly to significantly improve on the overall results. Interestingly, deep out of the money call options provide a similar protection while dragging significantly less on the performance. The best strategies show acceptable performance and risk measures but are still highly correlated with the stock market and do not outperform the latter. This study therefore concludes that strategies trying to harvest the "short VIX pre-mium" exhibit mediocre long-term performance with high downside risk which can only be successfully mitigated with expensive options, resulting in portfolios that are inferior to the S&P 500. The predictive power of the VIX future basis has vanished over time providing evidence of the increasing eÿciency of the VIX future market. The exceptional high returns of short VIX future strategies over certain time periods seem to be demanded by the market in order to compensate for the tail risk of losing everything within only a day. Investors who are tempted by high returns over certain time periods should be very cautious entering this trade. Without the ability to time the market, shorting the VIX seems to be a gamble rather than a solid long-term investment. |
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