Using VIX to trade SPY and S&P 500

 

VIX is a popular measure of the implied volatility of S&P 500 index options. You can read about the VIX using the link, but put shortly this is a mean reversion indicator: when the risk premium increses (VIX is rising in value) it might be wise to buy stocks and sell when VIX drops in value. As you can see, the VIX goes the complete opposite way compared to the stock market. It is a well known indicator and a lot of strategies can be found on the internet. However, many of them are quite complicated. Personally I have also tested a few of them.

VIX can also be traded. For example the ticker VXX is an ETF for the short to intermediate volatility. However, an ETF can never replicate VIX completely and VIX is also a spot indicator.

Here is one idea to trade the VIX: Go long SPY/ES when VIX breaks the upper bollinger band (BB). Exit after two up days in SPY/ES (I have a fetish for this exit). I’ll test this in several versions: one going for the extreme fills, and others going for a lot more fills. Test period is from 2005 until July 2012.

Strategy 1: I’m using a 10 day moving average for the BB. I like to use short time frames since they are more responsive. First, let’s try with a standard deviation of 3 for the upper band. When testing, there is no fills using 3 STD.

Strategy 2: Here are the results using a standard deviation of 2.5:

Avg #Trades #Wins Max.win Max.loss
1.44 25 21 5.22 -1.39

 

Here are the results using a standard deviation of 2:

Avg #Trades #Wins Max.win Max.loss
0.93 70 53 12.89 -9.56

 

 

Here are the results using a standard deviation of 1.75:

Avg #Trades #Wins Max.win Max.loss
0.56 82 58 4.46 -9.56

 

 

Here are the results using a standard deviation of 1.5:

 

Avg #Trades #Wins Max.win Max.loss
0.49 102 72 4.33 -13.43

 

 

Here are the results using a standard deviation of 1:

 

Avg #Trades #Wins Max.win Max.loss
0.42 135 94 4.2 -13.43

 

 

The basic principle here is to buy on weakness and sell on strength. I’ll leave it up to the reader to do some more research.

(The equity chart in this article shows returns using just 50% of the capital per trade, ie the return is the double allocating 100%. The reason is a bug in my software. )