Selling calls on VIX is a roundabout way to gain exposure to short /VX futures without having a futures account and without having to fiddle with SPAN margin requirements. If a trader has portfolio margin (PM) on their securities trading account, trading VIX options can offer administrative advantages in the form of margin-management and cash-management simplicity as well as potential margin relief through PM cross margining. Traders with a standard regulation-T (Reg-T) trading account won’t have the potential for cross margining as that’s a feature exclusive to PM accounts, but they can still benefit from the margin-management and cash-management administrative simplifications.
Short VIX call options aren’t a 1:1 replacement for short /VX, but they can achieve reasonably-close performance characteristics. The farther in the money (ITM) the position at order entry, the more it’ll be have like the underlying (VIX options reference /VX as the underlying, not the VIX index) and the less it’ll be influenced by the greeks associated with option instruments. Traders can also make less /VX-like and more option-like trades by targeting lower deltas, expressing sentiment regarding volatility of /VX (ticker: VVIX).
We’ll take a look at the backtest results of opening one short VIX call 7-DTE position each trading day from Nov 2 2015 (weekly-expiring VIX options were introduced mid-month Oct 2015) through May 31 2023 and see if there are any discernible trends. Delta targets include 5, 10, 16, 30, 50 (at the money), and 90 (far ITM, short /VX proxy).
We will also explore the performance of the s1 signal. The s1 signal is a boolean (TRUE / FALSE) daily indicator that attempts to identify the days in which short put and short vertical put positions on the S&P 500, and far-ITM short call and short vertical call positions on VIX, are most likely to be profitable at expiration. s1 is based on data from Cboe and S&P Global.
The s1 signal has yielded material improvements in total return, risk-adjusted return, max drawdown, and capital efficiency when selling puts on the S&P 500 vs a “market-agnostic” daily-entry strategy. That is, it avoided opening positions on days in which the realized [downward] volatility (RV) is anticipated to be greater at expiration than the implied [expected] [downward] volatility (IV).
When the S&P 500 experiences downward movements in excess of the market’s expectations, front-month /VX tends to experience material upward movements. If the s1 signal can help traders avoid these expectation-exceeding down days on S&P 500, could the same mechanic be applied to help traders avoid expectation-exceeding up days on /VX?
This study seeks to explore the following theses:
- if we open and hold-till-expiration a short VIX 7-DTE call position on the days in which s1 is TRUE, and take no action on the days in which s1 is FALSE, we will outperform, with regard to capital efficiency, a strategy that opens and holds-till-expiration every trading day
- if we open and hold-till-expiration a short VIX 7-DTE call position on the days in which s1 is FALSE, and take no action on the days in which s1 is TRUE, we will underperform, with regard to capital efficiency, a strategy that opens and holds-till-expiration every trading day
- applying the s1 = TRUE signal to a leveraged short VIX call 7-DTE strat can outperform a 100% SPY buy-and-hold portfolio with dividends reinvested (total return) with regard to total return, risk-adjusted return, and max drawdown
To test these theses we will:
- limit order entry to only the days in which s1 = TRUE to see if the strategy outperforms daily entry with regard to capital efficiency
- limit order entry to only the days in which s1 = FALSE to see if the strategy underperforms daily entry with regard to capital efficiency
- compare performance of s1 = TRUE strats against a 100% SPY buy-and-hold portfolio with dividends reinvested (total return) to see if the option strats outperform a buy-and-hold portfolio
Performance of the s1 signal is explored in different contexts in other non-paywalled s1 signal studies.
There are 18 backtests in this study evaluating over 21,400 short VIX call 7-DTE leveraged trades.
Let’s dive in!
Thesis 1: the s1 signal, when true, yielded up to a 453% (5.5x) improvement in capital efficiency vs a “market-agnostic” daily-entry strategy. It also improved premium capture by up to 50% (1.5x) vs daily entry.
Thesis 2: the s1 signal, when false, yielded up to a -43% (0.6x) deterioration in capital efficiency vs a “market-agnostic” daily-entry strategy. It also impaired premium capture by up to -44% (-0.6x) vs daily entry.
Thesis 3: the s1 signal, when true and leveraged (10-delta, max leverage of 5x), yielded 109% greater total return vs buy-and-hold SPY with dividends reinvested (total return). The same option strategy accomplished this with a 53% greater sharpe ratio and with a 6% shallower max drawdown. Complimenting the shallower max drawdown vs buy-and-hold, max drawdown duration is 239 days while buy-and-hold did not to recover by the backtest end date.
- Symbol: VIX
- Strategy: Short Call
- Days Till Expiration: 7-DTE +/- 4, closest to 7
- Start Date: 2015-11-02
- End Date: 2023-05-31
- Positions opened per trade: 1
- Entry Days:
- each trading day
- each trading day in which the s1 signal = TRUE
- each trading day in which the s1 signal = FALSE
- Entry Signal: s1 signal
- Timing 3:46pm ET
- Strike Selection
- 5 delta +/- 4.5, closest to 5
- 10 delta +/- 5, closest to 10
- 16 delta +/- 6, closest to 16
- 30 delta +/- 8, closest to 30
- 50 delta +/- 8, closest to 50
- 90 delta +/-8, closest to 90
- Trade Entry
- 5-delta short call
- 10-delta short call
- 16-delta short call
- 30-delta short call
- 50-delta short call
- 90-delta short call
- Trade Exit
- Hold till expiration
- Max Margin Utilization Target (short option strats only): 100% | 5x leverage
- Max Drawdown Target: 99% | account value shall not go negative
- Margin requirement for short CALL and PUT positions is 20% of notional
- Margin requirement for short STRADDLE and STRANGLE positions is 20% of the larger strike
- Margin requirement for short VERTICAL SPREAD positions is the difference between the strikes
- Margin requirement for short CALENDAR SPREAD positions, where the short option expires after the long option, is 20% of the short option
- Margin requirement for long CALENDAR SPREAD positions, where the short options expires before the long option, is the net cost of the spread
- Early assignment never occurs
- There is ample liquidity at all times
- Margin calls never occur (starting capital is set using hindsight bias so that max margin utilization never exceeds 100%)
- Apply a 20% discount to displayed results. For example, if a strat depicts a CAGR of 10%, assume that it’ll yield 8% in practice.
- Prices are in USD
- Prices are nominal (not adjusted for inflation)
- All statistics are pre-tax, where applicable
- Margin collateral is invested in 3mo US treasuries and earns interest daily
- Option positions are opened at 3:46pm ET
- Option positions are closed at 3:46pm ET (4:00pm if closed on the date of expiration)
- Commission to open, close early, or expire ITM is 1.00 USD per non-index underlying (eg: SPY, IWM, AAPL, etc.) contract
- Commission to open, close early, or expire ITM is 1.32 USD per index underlying (eg: SPX, RUT, etc.) contract
- Commission to expire worthless is 0.00 USD per contract (non-index and index)
- Commission to open or close non-option positions, if applicable, is 0.00 USD
- Slippage is calculated according to the slippage table
- Starting capital for short option backtests is adjusted in $1000 increments such that max margin utilization is between 80-100%, closest to 100%, of max margin utilization target
- Starting capital for long option backtests is adjusted in $1000 increments such that max drawdown is between 80-100%, closest to 100%, of max drawdown target
- Positions that have an exit date beyond the backtest end date are excluded
- For comprehensive details, visit the methodology page
Hindsight bias was used to maximize Reg-T margin utilization for each strategy. This allows a “best case” scenario for the option strategy to outperform the benchmark by identifying the minimum amount of starting capital necessary to successfully (eg: avoid margin calls) complete the backtest.
Max Drawdown Duration
Average Trade Duration
Average Trade Delta
Compound Annual Growth Rate
Profit Spent on Commission
Short volatility strats have a tendency to generate small and consistent profits with occasional outsized losses that can wipe out months or years of profits in a single trade. Rather than trying to completely avoid these losing trades (the s1 signal does a great job of avoiding several of them), which is an impossible task, a better approach would be to make the trade less asymmetric.
VIX options are notably asymmetric relative to SPX options. When a short VIX call expires ITM, it’s usually far ITM. Selling far out-of-the-money (OTM) calls on VIX only exacerbates the issue due to effects of vega. We can see this when looking at the average win and average loss across delta targets.
The ratio of average loss to average win can be used as a proxy for [a]symmetry. The 5-delta strats experience ratios in the 14x range. That is, a loss is 14x greater in magnitude than a win. As we work our way closer to the money and in the money, the ratio decreases all the way down to the 0.4x range. That is, a loss is only ~40% greater than a win.
Let’s take a closer look at the 90-delta short VIX call 7-DTE trade. We’ll look at buy-and-hold SPY with dividends reinvested (total return), opening a 90-delta short call daily, opening a 90-delta short call only on days when s1 = TRUE, and opening a 90-delta short call only on days when s1 = FALSE.
Starting Capital and Leverage
Trading exclusively when the s1 signal = TRUE required a fraction of starting capital vs daily entry to successfully execute the strategy at a max-leverage target of 5x, without margin calls, for the duration of the backtest.
Of note is the ratio of max margin use to average daily margin use. The smaller the ratio, the less volatile the strategy. The greater the ratio, the more volatile the strategy. 96.25/3.84 equates to a 25x expansion in margin use over the duration of the backtest. Despite this sounding rather extreme, the expansion was limited to the 2015-2016 years.
Win Rate Stats
The s1 signal = TRUE strat had roughly half ( 691 / 1529 ) of the number of occurrences vs daily entry and experienced a greater average win, greater average loss, and greater win rate.
Profit and Loss Stats
The s1 signal = TRUE strat yielded 70% of the income vs daily entry while placing 55% fewer trades and requiring 72% less starting capital.
More concisely, s1 signal = TRUE improved total return by 153% ( 2535.93 / 1001.67 – 1 ) and improved premium capture by 25% ( 22.2 / 17.78 – 1 ).
The s1 signal = TRUE strat yielded ~460% greater average PnL per trade vs daily entry.
The s1 signal = TRUE strat yielded a 34% shallower max drawdown but with a 127% longer max drawdown duration vs daily entry.
Distribution of s1 signals
The s1 = TRUE signal, while suggesting order entry on roughly half the trading days since 2007, is not evenly distributed throughout time. Here’s a breakdown of participation rate by year:
The historical s1 signal boolean values are available for download in the trade log store.
Download Trade Logs
Private, Custom Backtests
Visit the trade log store and download the data used in this and other backtests.
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