VIX Futures Trading Strategy Backtest And Example
Want to know about the VIX futures trading strategy? Introduced in 2004, VIX futures offers market participants the ability to trade a liquid volatility product based on the VIX Index — an index that measures implied volatility in the U.S. equity market. VIX is one of the most common barometers of market sentiment. For speculative traders, the index is not only a useful tool for assessing risk, as its futures also presents a way to speculate on volatility itself.
A VIX futures strategy refers to the methods and techniques you can use to trade VIX futures, which are financial derivative products that represent a contract to trade a specified unit of the index at a pre-agreed price on a future date.
This strategy may include using technical or fundamental indicators to analyze the market in order to determine an exact entry point. VIX futures trade on Cboe Futures Exchange (CFE) and allows traders to speculate on volatility and diversify their portfolio.
VIX strategies video
YouTube video with 4 backtested trading strategies.
In this post, we answer some questions about the VIX futures strategy and we also make a backtest. We would also like to remind you that we have hundreds of trading strategies in our library.
What are VIX futures?
VIX is a real-time market index that measures implied volatility — the market’s expectations for volatility over the coming 30 days — in the U.S. equity market. It was created by the Chicago Board Options Exchange (CBOE) in 1993. Also known as the fear index, VIX is one of the most common barometers of market sentiment; investors use it to gauge market volatility expectations. But apart from being a tool for risk assessment, it offers a tradable product — the VIX futures.
VIX futures are futures contracts whose underlying asset is the VIX Index. It is a financial derivative product that represents a contract to trade a specified unit of the index at a pre-agreed price on a future date. VIX futures reflect the market’s estimate of the value of the VIX Index on various expiration dates in the future. It allows market participants to trade a liquid volatility product based on the VIX Index methodology. With this futures contract, market participants have the opportunity to implement their view using volatility trading strategies, including risk management, alpha generation, and portfolio diversification.
What is a VIX futures strategy?
A VIX futures strategy refers to the methods and techniques you can use to trade VIX futures. This strategy may include using technical or fundamental indicators to analyze the market in order to determine the right entry and exit point.
You must have a solid trading strategy if you want to profit from trading the VIX futures. Your VIX futures strategy should not only include precise entry and exit signals, but also your risk management and position sizing techniques. You can use your VIX futures strategy for portfolio diversification, speculative trading, and arbitrage trading.
VIX futures vs. spot index
Investors use VIX derivatives, such as spot VIX and VIX futures, to hedge market risk, but both have a negative correlation to the equity market.
However, VIX futures contracts do not precisely track spot VIX, so it is crucial for investors to understand their unique characteristics and limitations as a hedge to their equity exposure.
The S&P 500 VIX Short-Term Futures Index only captures about half of the spot movement, necessitating investors to consider the appropriate hedge ratio. Additionally, rolling from the first-month futures to the second-month creates a long-term performance drag in the index, making it generally costly to use it as a long-term hedge.
To give you an idea about the difference, please see the chart below made by S&P in an article called Identifying the Differences Between VIX Spot and Futures:
Therefore, it is worth noting that utilizing the index as a long-term hedge can be expensive for investors.
VIX futures strategy backtest
We have backtested VIX futures in the past, but unfortunately, we have not found something that we believe is valuable to trade.
Instead, we backtest what we believe is the most valuable use of the VIX: the spot index to trade stocks. Below is a chart showing how the VIX index goes from low to high in a matter of a few days:
You want to buy stocks when there is fear and blood in the streets, which is when the VIX is high.
Let’s make a backtest using the VIX spot index and the following trading rules:
Trading Rules
THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES
CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES
(You get the code of this strategy plus hundreds more if you become a member.)
The equity curve of the strategy looks like this for SPY since its inception in 1993:
The drawdowns look like this:
These are the performance metrics and statistics:
The average gain per trade is 0.64%, but the annual return is lower than Buy&Hold. However, that can be explained by the low investment time: 13.3% (see exposure). The strategy is invested only 13.11% of the time, and thus it translates into a risk-adjusted return of 44.06%. We calculate risk-adjusted return as the return divided by time spent in the market (5.78% divided by 0.1311).
Another major positive with the strategy is the low max drawdown: 23% – less than half of Buy&Hold’s 55%!
There are only two down years! The strong returns when the overall stock market is down are worth noting: 2008 and 2022.
What is the seasonality of VIX futures?
Seasonality is a concept in financial trading that describes the tendency of an asset’s price to move in a fairly predictable pattern during certain times of the year. Periods can refer to months or seasons (winter, spring, summer, and fall) of the year.
The VIX seasonality chart below shows that the index tends to perform better during the summer and fall months than other seasons of the year. It tends to be stagnant during the winter and declines during the spring.
What moves the VIX — What affects the VIX the most?
The primary factor is the phase of the stock market cycle — the bullish or bearish phase. As the S&P 500 Index is rising during the bullish phase of the stock market cycle, the VIX Index and the VIX futures would be declining. On the flip side, when the bearish phase of the market cycle is setting in, the VIX Index and the VIX futures would rise, indicating fear in the market.
Another factor is the contango and backwardation effects that arise from the mean-reverting nature of the spot VIX Index at extreme values and the fact they are priced into the VIX futures. When the spot VIX index is at very low values, the VIX futures contracts sell at a premium (contango), and when the spot index is at extremely high values, the futures contracts sell at a discount (backwardation). (Source)
How are VIX futures traded?
The VIX futures are available for trading on the Cboe Futures Exchange. The contract trades from Monday to Friday, from 8:30 a.m. to 3:15 p.m. CT for the regular session, but there can extended session from 3:30 p.m. to 8:30 am the next day, except on Monday when it ends at 5:00 p.m. the same day.
There are two contract types: the full VIX futures contract and the mini VIX futures contract. One contract unit of the full contract is equivalent to the value of the index multiplied by $1,000, while that of the mini contract is one-tenth of the full contract. Price quotation is in index points to three decimal places.
There are contracts for every month. On expiry, the contract is financially settled. Trading terminates at 8:00 a.m. CT on the final settlement day, which is on the Wednesday that is 30 days prior to the third Friday of the calendar month immediately following the month in which the contract expires (30 days before the S&P- 500 option expiration).
How do you start trading VIX futures?
The contract is traded through a futures broker, who can grant you access to the exchange and also help to clear your trades. So, to begin trading, you must first open an account with a futures broker and fund it. Futures are leveraged instruments, so you don’t need to have the total worth of the VIX futures contract to trade it.
You can also trade the CFD contract if there is an online CFD broker that offers it. Note that CFD trading is simply a contract between you and the broker to exchange the price difference from when you open a trade t the time it is closed, so you have to trade with a broker you can trust.
What is the VIX trading at?
As of December 19, 2022, VIX futures (VX) were trading at 22.450. See the chart here on TradingView.
Note that the price changes from time to time, so what is quoted here may not be the price it would be trading when you are reading this post. To get the price in real time, click on the link.
What’s the VIX futures hour?
The VIX futures contract trades on the Cboe Future Exchange from Monday to Friday, from 8:30 a.m. to 3:15 p.m. CT for the regular session. Apart from the regular session, there is the extended session from 3:30 p.m. to 8:30 am the next day, except on Monday when it ends at 5:00 p.m. the same day.
Where can I find trading charts?
You can find the chart on any trading platform that provides chart services. If your platform does provide charts, you can use TradingView, which provides free access to the charts of various instruments. However, to connect TradingView to your broker, you must subscribe to its Pro services.
Apart from TradingView, another chart you can use is Yahoo Finance, which offers free chart services. If you want a paid charting service, you can subscribe to a paid third-party platform like MultiCharts.
What are the trading symbols for VIX futures?
The trading symbol for the index is VIX, while the product code for the futures contract is VX.
What is the specification for the VIX futures contract?
CFE’s VIX futures are of two contract types: the full VIX futures contract and the mini VIX futures contract. One contract unit of the full contract is equivalent to the value of the index multiplied by $1,000. A contract unit of the mini contract is one-tenth of the full contract, which is the index’s value multiplied by $100. Price quotation is in index points to three decimal places.
There are contracts for every month. On expiry, the contract is financially settled. Trading terminates at 8:00 a.m. CT on the final settlement day, which is on the Wednesday that is 30 days prior to the third Friday of the calendar month immediately following the month in which the contract expires (30 days before the S&P- 500 option expiration).
Why should you start trading VIX futures?
These are some of the reasons to trade VIX futures:
- To hedge risks in the stock market: VIX futures have a strong negative correlation with the stock market, so you can use it to hedge your position in stocks.
- To diversify your portfolio: You can use the VIX futures contracts to diversify your portfolio away from equities
- To speculate on VIX fluctuations: As you cannot trade an index directly, you can use VIX futures to speculate on VIX Index.
What is the contract size?
One contract unit of the full contract is equivalent to the value of the index multiplied by $1,000, while that of the mini contract is one-tenth of the full contract. Given that the current value of the VIX Index is 22.450, as of writing, the total USD worth of the full contract is $22,450 ($1,000 X 22.450). By extension, the total USD worth of the mini contract is $2,245 (1/10th of the full contract).
What is the tick size?
The tick size for the full contract is $50.00 per contract.
What is the minimum price fluctuation for VIX futures?
The minimum price fluctuation is 0.05 per tick.
Are there any ETFs?
Yes, there are many VIX ETFs. These are some of them:
- iPath Series B S&P 500 VIX Short Term Futures ETN (VXX)
- ProShares VIX Short Term Futures ETF (VIXY)
- ProShares VIX Mid Term Futures ETF (VIXM)
What factors affect VIX prices?
The main factors that affect VIX prices are as follows:
The phase of the stock market cycle: The stock market moves in bull and bear cycles. During the bullish phase of the stock market cycle, the S&P 500 Index would be rising, while the VIX Index and the VIX futures decline. On the other hand, during the bearish phase of the market cycle, the VIX Index and the VIX futures rise.
The contango and backwardation effects: Normally, the spot VIX Index tends to mean-revert at extreme values. This characteristic pattern is priced in the VIX futures such that when the spot index is at very low values, the futures contracts sell at a premium (contango), and when the spot index is at extremely high values, the futures contracts sell at a discount (backwardation). Many traders make both VIX contango strategy and VIX backwardation strategy. However, we won’t cover that in this article.
What is the all-time high for VIX futures?
Based on the TradingView chart for VIX futures (VX), the all-time high of the VIX futures contract is 80.850, which it reached in March 2020.
What are the biggest risks in trading VIX futures?
The biggest risk when trading any type of futures, including the VIX futures, is from adverse price movement because futures are leveraged instruments. The use of leverage can magnify losses because the losses are calculated based on the size of the contract, rather than the margin deposited. If you trade with a 20x leverage, a 1% negative movement would lead to a 20% loss, while a 5% adverse movement would wipe out your account.
What is the settlement method?
The VIX is financially settled – no physical settlement.
What is the settlement procedure?
The final settlement value for VX futures shall be a Special Opening Quotation (SOQ) of the VIX Index calculated from the sequence of opening trade prices during the special opening auction conducted on days when VX futures settle.
What is the block minimum for VIX futures?
200 contracts
What is the difference between VIX futures and the CFD for VIX?
Futures trade on standard exchanges, while CFDs are simply contracts you enter with a CFD broker. Another difference is that CFDs have no expiry dates, unlike futures.
Which forex pair is the same as VIX futures
VIX futures CFD.
What are some important dates for this market?
Some of the important dates for the VIX market include:
- January 19, 1993: The VIX Index was created by the Chicago Board Options Exchange.
- March 26, 2004: VIX futures were launched on the CFE.
- February 2006: Options on VIX futures were introduced on the CFE.
What is the highest level VIX has ever been — its all-time high?
Based on the TradingView chart for the VIX Index, the highest level the index ever reached was 89.53 in October 2008.
What is the lowest level VIX has ever been — its all-time low?
Based on the TradingView chart for the VIX Index, the lowest level the index ever got to was 8.56, which happened in November 2017.
Conclusion
You can use the VIX futures strategy to hedge risks in the equity market, diversify your portfolio away from stocks, or speculate on the fluctuations of the VIX Index.
Why should you start trading VIX futures?
VIX futures provide opportunities to hedge risks in the stock market, diversify investment portfolios away from equities, and speculate on volatility trends, making them a valuable addition to a trader’s toolkit.
What factors affect VIX prices?
The phase of the stock market cycle, indicating bullish or bearish trends, significantly influences VIX prices. Additionally, contango and backwardation effects play a role, as the VIX futures contracts are priced based on the mean-reverting nature of the spot VIX Index.
How do I start trading VIX futures?
To start trading VIX futures, individuals must open an account with a futures broker providing access to the Cboe Futures Exchange. After funding the account, traders can actively participate in VIX futures markets.