VXX ®

iPath® S&P 500 VIX Short-Term FuturesTM ETN

Mid-Term investment methodology on

Volatility with a proven edge over market
- An institutional approach to trading with robust results -
Why you should buy this course? VXX ®

• Includes a proven edge over market

• Diversification from Short-Term strategy
• More conservative / Less riskier
• Proven and consistent methodology
• Simple rules to apply
• Basic options knowledge needed
• Increase your trading knowledge in Volatility related assets
• Live performance will be posted
• Continuous support to doubts / questions

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 VXX ®
iPath® S&P 500 VIX Short-Term FuturesTM ETN

Mid-Term investment methodology on

Volatility with a proven edge over market
- An institutional approach to trading with robust results -
Course Contents VXX ®

• Instructor Background
• Volatility Trading vs Stock Trading
• Why investing in Volatility is so interesting? But …
• Instruments to trade Volatility
• Concepts on VIX® Futures pricing structure
• The trading approach
• Backtesting / Strategy Optimization
• Strategy Rules

4
Instructor Background VXX ®

• Degree in Engineering and MBA

• More than 10 years experience in Management Consulting

• Option trading for more than 6 years

• Volatility trading in the past 3 years
- Started with XIV and SVXY (buy ETNs)
- Evolved on volatility trading with options

• Currently trading exclusively SPX, SPY and VXX strategies

- Including hedging technics to protect capital

5
Price evolution of a stock (TWTR) VXX ®

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The VIX® Index VXX ®

Zone 3

Zone 2

Zone 1

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Attractiveness of investing in Volatility VXX ®

Given the characteristics of price action of VIX® (and volatility in general),

it is more predictable than price movements of a stock or Index

(+) When Volatility is High (VIX® in Zone 3), it is expected to come down after the market
settles (and if it is predictable there should be opportunities to make money with an edge)

(+) When Volatility is Low (VIX® in Zone 1), it is expected to continue in short term on these
area until, unexpectedly Volatility pops

(+) Long volatility tradeable instruments have long term depreciation due to its construction;
and we can benefit from it!

(-) Volatility is more unpredictable on the low side! When it pops, could be violent (including
overnight, gapping in the next trading day!)

Volatility traders used to say: “Volatility takes the stairs down, but the
elevator Up!” 8
Some drawbacks that you should be aware VXX ®

Investing in Short Volatility is high risk and strategies must

take into consideration this fact!

Money management is crucial for long term appreciation!

Short volatility strategies are a good complement of portfolio

diversification!

Diversification with several strategies (even within the same

asset) will improve overall portoflio profitability and reduce
risk

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Course Contents VXX ®

• Instructor Background
• Volatility Trading vs Stock Trading
• Why investing in Volatility is so interesting? But …
• Instruments to trade Volatility
• Concepts on VIX® Futures pricing structure
• The trading approach
• Backtesting / Strategy Optimization
• Strategy Rules

10
VIX® Index properties VXX ®

• Computed with several options prices including several strikes to reflect 30 day
forward expected broader market (SPX) volatility
- When markets start to fall, investors start buying Put Options or VIX Call options to protect their
portfolios and this increases volatility (VIX has an opposite relation with SPX)

• Majority of time is below 12 (although in the past 2 years there is a decreasing

tendency – given the continuous SPX successive years of appreciation)

• Mean reverting: the most relevant property of VIX® (and volatility in general)
- When going high, above 20, it is expected to revert and come to 11-12 range in short period of
time
- When going to 9-10 range it is expected to move higher

• But VIX® is NOT tradable!

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Instruments to trade Volatility VXX ®

• Given that VIX® is not tradeable, there are ETNs (Exchange Trading Notes) that
try to follow the Volatility Index (either on the Long side or the Short side of it)

• VIX® futures are the closest instruments and those ETNs are composed of them

Instrument Long / Short Volatility Leverage Options

VXX Long 1x Yes

XIV Short 1x No

SVXY Short 1x Yes Lower Liquidity /

High Options
Spreads – to
UVXY Long 2x Yes avoid!

VXX is the most liquid instrument with tight stock and options spreads
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Price comparison between VIX® and VXX® VXX ®

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VXX® ETN price evolution for past 2 years VXX ®

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 VIX® futures term structure VXX ®

Spot VIX®

• Buying High Valued Future (Jan 18) and Selling Lower priced Future (Dec 17)
will erode Value of VXX® ETN
• Futures in the settlement date will have the same value as the Spot VIX®

Source: www.vixcentral.com 15
 How VXX® works* VXX ®

• To mimic VIX index, VXX continuously buys Month n+1 “VX futures” and sells
Month n “VX futures”. As per today VXX has a certain percentage of December
Futures and remaining percentage of January futures

• /VX futures are quoting the expected volatility of SPX on the settlement date
of each contract

• Barclays updates daily the components of VXX ETN. As long as time passes Jan
18 percentage will increase (and Dec 17 will increase) until the Dec settlement
date (Dec 19)

Buy
Sell

Note:Barclays website for VXX: http://www.ipathetn.com/US/16/en/details.app?instrumentId=259118 16

* The other ETNs works similarly; XIV/SVXY, since are short volatility inverts the futures that are bought and sold
Course Contents VXX ®

• Instructor Background
• Volatility Trading vs Stock Trading
• Why investing in Volatility is so interesting? But …
• Instruments to trade Volatility
• Concepts on VIX® Futures pricing structure
• The trading approach
• Backtesting / Strategy Optimization
• Strategy Rules

17
 VIX® futures term structure / Contango VXX ®

Spot VIX®

• Majority of time, the VIX® futures structure is in Contango (~85% of the time):
ascending futures pricing
• This impacts negatively VXX® ETN price. That’s why it has negative drag as seen
before when comparing with VIX®
Source: www.vixcentral.com 18
 VIX® futures term structure / Backwardation VXX ®

• In turbulent times, when volatility increases sharply, the VIX® futures structure inverts
and defined as in Backwardation
• This fact inverses the impact of VXX® ETN price and it increases as it now is buying lower
priced future (month n+1) and selling the higher priced future (month n)
• Usually the Backwardation status will only last few days or weeks (when markets surpass
a critical moment and volatility start to decrease)
Source: www.vixcentral.com 19
Key concepts on VIX® futures pricing structure VXX ®

Spot VIX®

• % Roll Yeld: Spot VIX® / Month N Future - 1= 10,930 / 10,01 -1 = 9,2%

• % Contango (Month N / Month N+1) - 1 = 12,320 / 10,930 – 1 = 12,7%

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% Contango and Roll Yield are a headwind for VXX ®
VXX® price

• In the given example, %Contango = 12,7%, which means, if all other variables do not
change (ex, volatility), VXX® will decrease daily about 0,5% of its value, only accounting
for Contango

• Since futures are also loosing value (given contango state) and settle at Spot VIX® it
shouls also be added to the equation the Roll Yield

• Both affects negatively the VXX® price in the long run

Takeaways:

• DO NOT take Long positions in VXX® (very difficult to profit on a strategy with
long positions)

• Only take short positions in VXX® when % Contango is >5% (or if market crosses
from Backwadation to Contango – which means volatility is decreasing and
market is going back to normal state and VXX has this headwind
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Course Contents VXX ®

• Instructor Background
• Volatility Trading vs Stock Trading
• Why investing in Volatility is so interesting? But …
• Instruments to trade Volatility
• Concepts on VIX® Futures pricing structure
• The trading approach
• Backtesting / Strategy Optimization
• Strategy Rules

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The trading approach VXX ®

• Consistency and capital appreciation will only be achieved if both concepts (below) would
be incorporated in your trading

• I also see my trading as a business and I have clear goals on it:

- Ex, I target for a 3%-5% monthly return (>50% annually)
- I know exactly what is my Net Liquidation target for the end of each month

• (1) Statistical Edge

- Which trade, in the long run (ex, 2-3 years), produces consistently a profit ?

• (2) Trade (and Money) Management

- For each trade I enter, I know exactly what is my profitability goal and maximum loss (and
I stick to it)
- I also do not enter similar/correlated trades that accounts for more than 5% of my total
portfolio
- Given the amount of money at risk, how can I hedge positions to protect from a sudden
event ?
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(1) Statistical Edge – The basis of the VXX® Trade VXX ®

VXX 60 Day Price Variation (%) Histogram*

78% of time VXX® ends

lower 60 days after
entering a trade,
independently of what the
day is choosen

*Analysis from 1Nov13 until 31Out17 (data source: Yahoo.com). Price comparison with rolling days distant 60 days
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(2) Trade (and Money) Management VXX ®

Avg Winner 50 25 25
Avg Looser -50 -50 -100
• Investing seek capital
Win Rate Expectancy appreciation in the long run
80% 30 10 0 in a controlled way
70% 20 2,5 -12,5
65% 15 -1,3 -18,8 • Gambling seeks big short
60% 10 -5,0 -25,0 term gains!
50% 0 -12,5 -37,5
40% -10 -20,0 -50,0

• Trade Management / Cut losses are key to consistency in the long term!

• For a Win rate of about 65%, a loss equal to the expected win value will drive positive
outcome in the long term; allowing losses above this level will produce low to negative
statistical expectancy

• Money management rules that I apply

- I do not have more than 5% of my total account value invested in a unique trade
- I also add VIX Call Spreads to hedge against a sudden volatility increase (later discussed) – recall
the 50% increase in VXX price at 8,5% of the time 25
Course Contents VXX ®

• Instructor Background
• Volatility Trading vs Stock Trading
• Why investing in Volatility is so interesting? But …
• Instruments to trade Volatility
• Concepts on VIX® Futures pricing structure
• The trading approach
• Backtesting / Strategy Optimization
• Strategy Rules

26
How to profit from VXX® price decay ? VXX ®

• On a mid-term strategy, more conservative, than the “Weekly Short Verticals”, another good option I
found so far (in terms of consistency, profitability and trade management) is buying Puts
- Using a sistematic approach, with clear rules, to avoid emotions
- Risk is controled (even in the event of a big volatility spike) – Maximum loss is capped
- On a specific day, a new position is entered, at a predifined Delta (to profit from VXX price decay)

• Shorting directly the ETN is more margin consuming and risky (in the event of big spike in volatility);
also the cost to borrow charged by the broker
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But what strike and timeframe produce the best VXX ®
results when buying VXX® Puts ?

• The rules optimization came from a professional backtesting software (CMLViz*)

designed for option trading strategies development

• I have tested it for several combinations of strikes and different time frames for
this ETN

• There is a consistent and highly profitable strategy buying Puts at 60/70 Deltas
with 60 DTE (Days To Expiration):

*website of this service is http://tm.cmlviz.com/ (Options Backtester Service) 28

 Tests for strike optimization and DTE for VXX® Put VXX ®
buying (I)

• TEST 1*: VXX Put Buying (30 DTE) test results:

3 years
Data

5 years
Data

*Analysis made with no Money management criteria and held until expiration 29
 Tests for strike optimization and DTE for VXX® Put VXX ®
buying (II)

• TEST 2*: VXX Put Buying (60 DTE) test results:

3 years
Data

5 years
Data

*Analysis made with no Money management criteria and held until expiration 30
 Tests for strike optimization and DTE for VXX® Put VXX ®
buying (III)

• TEST 3*: VXX Put Buying (90 DTE) test results:

3 years
Data

5 years
Data

*Analysis made with no Money management criteria and held until expiration 31
VXX® Put Buying Backtest Resume VXX ®

3 Years
Long Put DTE
>60% Wins 30 45 60 75 90
70 4090 3537 4859 3862 4564
60 3510 2801 4345 3513 4071 The Put Buying Strategy at
Delta 50 3720 3204 3485 60 DTE and 70 Delta
40 2804 2628 2640 produces the highest
30 2021 1952 1783 return! Tested in the
simplest form (held until
expiration and not
5 Years considering contango
Long Put DTE levels), is capable of
>60% Wins 30 45 60 75 90 achieving a profitability of
70 4532 6241 5110 5623 more than 500% annually!
60 5519 4109 4652
Delta 50 4570 3494 3593
40 3427
30

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Course Contents VXX ®

• Instructor Background
• Volatility Trading vs Stock Trading
• Why investing in Volatility is so interesting? But …
• Instruments to trade Volatility
• Concepts on VIX® Futures pricing structure
• The trading approach
• Backtesting / Strategy Optimization
• Strategy Rules

33
Trade Rules VXX ®

1. Check if Contango level is above 2% (if below delay entering a trade)

2. Check VXX option chain and see if there is availability of 58-62 DTE

3. Open the desired option chain and look for the 70 delta VXX Put and buy one contract
• If on the day (or the day before) VXX has increased value consider to open 2 contracts
• Price should be betweem 9 and 11 (total investment per contract will be around 1.000USD)
• If, during the trade there is a new volatility spike, you could open a new order benefiting from a
lower Put price, if you have higher risk tolerance

4. Trade Management
• Close trade if loss reach 50% of th investment value (~500€ per contract)
• Close it one day before it expires to avoid being assigned (either with a loss or profit
• Close positions before any reverse stock-split on VXX
• I suggest close it for profit if you enter a new order for a new 60 day cycle and maintain risk level
(unless you can support more than one open order – do not invest more than 50% of your
account capital)

This is a proven mechanical strategy that could produce even better results than
the tests presented before, due to Contango and Spread value filters!
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Trade example (1) – Choosing the 70 Delta Put VXX ®

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Trade example (1) – Analysis of 70 Delta VXX Put VXX ®

1. Max Loss is the price paid for the Put ($885); although if loss reaches 50% of that value, close the
trade
2. Unlimited max profit – Theta negative / Delta negative position! 36