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 vertical call options aren’t a 1:1 replacement for hedged short /VX, but they can achieve reasonably-close performance characteristics. The farther in the money (ITM) the short leg 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 on the short leg, expressing sentiment regarding volatility of /VX (ticker: VVIX).
We’ll take a look at the backtest results of opening one short VIX vertical call 7-DTE position each trading day from Nov 2 2015 (weekly-expiring VIX options were introduced mid-month Oct 2015) through Jul 31 2023 and see if there are any discernible trends. Short delta targets include 5, 10, 16, 30, 50 (at the money), and 90 (far ITM, short /VX proxy). The long call will be struck at 5-delta as a “black swan” hedge. The short 5-delta call will be paired with a long 2-delta call.
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 vertical call 7-DTE 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 vertical call 7-DTE 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
- if we open and hold till expiration a short VIX vertical call 7-DTE position on the days in which s1 is TRUE, with a max margin utilization target of 100%, we will outperform, with regard to total return, risk-adjusted return, and max drawdown, a 100% SPY buy-and-hold portfolio with dividends reinvested (total return)
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
- limit order entry to only the days in which s1 = TRUE, with a max margin utilization target of 100%, to see if the strategy outperforms a 100% SPY buy-and-hold portfolio with dividends reinvested (total return) with regard to total return, risk-adjusted return, and max drawdown.
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 20,700 short VIX vertical call 7-DTE trades.
Let’s dive in!
Thesis 1: the s1 signal, when true, yielded up to a 126% (2.3x) improvement in capital efficiency (50/5-delta) vs a “market-agnostic” daily-entry strategy. It also improved premium capture by up to 65% (1.7x) (90/5-delta) vs daily entry.
Thesis 2: the s1 signal, when false, yielded up to a -68% (0.3x) deterioration in capital efficiency vs a “market-agnostic” daily-entry strategy. It also impaired premium capture by up to -59% (0.4x) (90/5-delta) vs daily entry.
Thesis 3: the s1 signal, when true and targeting a max margin utilization target of 100%, yielded up to a 173% greater total return vs buy-and-hold SPY with dividends reinvested (total return). The same option strategy accomplished this with a 72% greater sharpe ratio but with a 10% deeper max drawdown. Meanwhile, the max drawdown duration is 210 days while buy-and-hold did not to recover by the backtest end date.
- Symbol: VIX
- Strategy: Short Vertical Call
- Days Till Expiration: 7-DTE +/- 4, closest to 7
- Start Date: 2015-11-02
- End Date: 2023-07-31
- 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
- 2 delta +2 / -1, closest to 2
- 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, 2-delta long call
- 10-delta short call, 5-delta long call
- 16-delta short call, 5-delta long call
- 30-delta short call, 5-delta long call
- 50-delta short call, 5-delta long call
- 90-delta short call, 5-delta long call
- Trade Exit
- Hold till expiration
- Max Margin Utilization Target (short option strats only): 100%
- 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
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.
Two tactics that a trader can use to increase risk/reward symmetry include increasing the delta target and limiting the max loss.
Increase Delta Target
Due to the effects of vega, lower-delta short-option entries can experience greater swings in price (read: margin expansion) relative to credit received. A backtest of 7-DTE short VIX calls demonstrates this effect.
Targeting a higher delta decreased the ratio of average win to average loss from 1-to-15.7 (5-delta daily-entry) to 1-to-1.47 (90-delta daily-entry).
Limit Max Loss
By structurally limiting max loss with a protective long leg, all delta targets experienced a reduction in trade asymmetry. The daily-entry 5-delta short call with a 2-delta long call had an average win-to-average loss ratio of 1-to-6.17, while the daily entry 90-delta short call with 5-delta long call had an average win-to-average loss ratio of 1-to-1.32.
Let’s take a closer look at the 90/5-delta short VIX vertical call 7-DTE trade. We’ll look at buy-and-hold SPY with dividends reinvested (total return), opening a 90/5-delta short VIX vertical call 7-DTE daily, opening a 90/5-delta short VIX vertical call 7-DTE only on days when s1 = TRUE, and opening a 90/5-delta short VIX vertical call 7-DTE only on days when s1 = FALSE.
Starting Capital and Leverage
Trading exclusively when the s1 signal = TRUE required 21% less starting capital vs daily entry to successfully execute the strategy at a max-margin target of 100%, without margin calls, for the duration of the backtest.
Win Rate Stats
Profit and Loss Stats
s1 signal = TRUE improved total return by 3% while placing 54% fewer trades and requiring 21% less starting capital vs daily entry. This was accomplished by improving premium capture by 65%.
The s1 signal = TRUE strat yielded a 10% deeper max drawdown but with a recoverable max drawdown 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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