February 8, 2018
With Monday's "demolition" of short volatility, and subsequently XIV, many are wondering whether these products will survive the next recession. Outside of the termination of XIV, short volatility products have historically tracked their indicative value very accurately. Many speculate that Credit Suisse caused the short volatility explosion by attempting to liquidate holdings. Barring another black swan event (which is a big IF), SVXY will most likely survive the next recession. But there's another worry volatility investors are focused on: holding SVXY during the next "black swan" VIX futures event.
Fortunately, our volatility strategies were in cash during the debacle; in fact, our Volatility Strategy and Conservative Volatility Strategy are both up 2% YTD. Our Traditional Asset Strategy was in bonds during the rout, so that strategy was able to profit as the S&P 500 fell 4.10%. The question remains: How can we determine whether we'll be able to avoid massive losses during the next recession? We review our historical performance. Unfortunately SVXY's inception occurred in late 2011, so there is no live data available to backtest through the 2008 Financial Crisis. Luckily, there is fairly accurate simulated data available; presented below is the backtest of our Volatility Strategy from February 2008 to 2017.
As you can see, our strategy certainly "held its own" during the 2008 Financial Crisis. That is a "stress test" that may never be seen again; granted, these VIX products weren't a part of the investing environment at the time, so their impact wasn't felt in the volatility markets during 2008.
We specifically highlighted months with greater than 10% moves in our Volatility Strategy. You'll immediately notice that there's much more green than red. In fact, there are 36 months in which our strategy returned greater than 10% and only 2 months in which it fell by more than 10%. At the risk of sounding like a broken record, the most important aspect of any volatility strategy is risk management. We've seen how dangerous these volatility products are, so safety is the priority. Avoiding large drawdowns is the key to success in short volatility land.
One key point to highlight is our Volatility Strategy's performance with SVXY relative to XIV. The annualized returns were within 1.5% of each other after nearly 10 years of trading. The drawdowns were also within ~1% of each other. This is expected, as both XIV and SVXY track the same index (SPVXSP) and, thus, should perform almost identically.
So, yes. BCK Volatility will continue to manage its profitable portfolio of strategies. The Volatility Strategy will begin to trade SVXY which, as evidenced by backtests, performs virtually the same as XIV did with our strategies.
We felt it was important to share our strategy's ability to avoid massive risk and profit regardless of the macroeconomic environment. When trading volatility products, it's critical to be fully aware of the risks involved.
If you have any questions or comments, please email us.