February 14, 2018
This post is a test of Tony Cooper's Momentum Volatility Strategy. The "Momentum Strategy" is straightforward; hold the single ETP (XIV, VXX, ZIV, VXZ) that has the best returns as measured over the last 83 days (83 day return must be positive, else the strategy will be in cash). He chose "83" days because of its performance versus other values. The other values tested for "days" ranged from 20 - 90 . It's key to point out that this strategy is based on a different methodology than most are used to seeing in the volatility space.
Tony Cooper notes:
"Measurements show that for long intervals of time XIV returns have a Sharpe Ratio (SR) between 2 and 3. For example, regime 1 (2004 - 2007) has SR = 2.63, and there are other periods longer than a year where SR > 2. A goal is to be able to time these periods."
The "Momentum Strategy" is based on the idea that there are different "volatility regimes" that can last for years at a time. Looking at the regimes below, it's clear they are divided by volatility ETP performance.
His hypothesis was that the best performing ETP over the past 83 days will continue to perform well until there is a "regime change." A regime change will, in theory, be differentiated by a switch from long volatility products to short volatility products, or vice versa.
Most volatility strategies look to avoid day to day drawdowns and identify which individual days are "ideal," in terms of risk and reward. Tony Cooper's "Momentum Strategy" dismisses that methodology entirely. By holding the ETP with the best returns as measured over the past 83 days, the "Momentum Strategy" ignores day to day price movements and looks at periodical performance. Before looking at the data, we believe that the strategy will not work. Specifically, we believe that the strategy does not make "sense" when taking the behavior of volatility into account. Volatility has the ability to shift on a dime; the "Momentum Strategy" would adjust much too late. We would expect to see abnormally high drawdowns and a low CAGR.
The results of this strategy from 3/29/2011 - 12/29/2017 are as follows:
To be frank, the "Momentum Strategy" doesn't work. Its maximum drawdown is nearly the same as a Buy and Hold XIV strategy, but the annualized returns fall 15% below B&H. Both the Sharpe Ratio and the Ulcer Performance Index suffer from the effect of the strategy's parameter. The "Momentum Strategy" had performed extremely well in Tony Cooper's backtests (2004 - 2013); it boasted 84.6% annualized returns with a Sharpe Ratio of 1.46. As Tony Cooper warned, a regime changed occurred that made the strategy useless. In addition, the strategy fails to take numerous metrics and signals that affect volatility into account. Below are the monthly returns from the strategy; unfortunately, it would be unbearable to follow.
We cannot imagine that anybody would follow this strategy. Volatility trading strategies, like our own, must look at daily VIX related data in order to avoid massive drawdowns and poor performance. This has become essential in light of the XIV termination event, which resulted in >90% drawdown for its holders. Risk management must be the primary focus of any volatility strategy.
If you have any questions or would like us to test out other strategies, feel free to email us.