And just like that, the VIX has come full circle. Analyzing its mid-July departure from its long-term mean of 20, its turbulent filled, multi-month flight, and subsequent return home has been an interesting endeavor to say the least. It has once again reminded me of the “circle of volatility” that plays out time and time again. Expecting a reversion to the mean is a given. Unfortunately, the extent and duration of the occasional deviations from the mean remain ever elusive. Sometimes what begins as a short sprint from the all-powerful 20 level morphs into a long-lasting marathon on a road shrouded in darkness.
In sum, we know where the VIX is going, we just don’t know how or when it will get there.
The timeless John Maynard Keynes statement that, “Markets can remain irrational longer than you can remain solvent” comes to mind. The gunslingers who were quick on the trigger when fading the initial VIX pop in August were mercilessly punished as irrationality remained far longer than expected (by me at least). Though, I suppose irrationality is in the eye of the beholder. What appears irrational to one trader may be deemed quite sane by another.
As I’ve assessed my attempt to play this most recent VIX “foray from the 20″, I’ve identified one key mistake that has helped reiterate a lesson I’ve apparently needed to re-learn. In my exuberance to jump aboard the VXX express, I elected to take the most aggressive route possible by shorting stock (hello unlimited risk) and to add insult to injury I shorted way too many shares. Needless to say my misstep was exploited and a decent sum of money departed from my coffers. Of course, on my next attempt to wrangle the volatility beast, I won. For those of you keeping score that’s one win and one loss, or, in other words, a 50% win rate. Sufficient to make money? You bet. Provided of course the average gain dwarfs the average loss.
And, therein lies the rub. Many reason that the only way to overcome an overly large losing bet is to place an equally large bet in the next trade. But, that is quite the slippery slope. Better to return to normal position sizing ASAP so as to avoid turning a small misstep into a large leap in the wrong direction.
By deviating from both consistently and properly position sizing I’ve threatened the integrity of my edge. Anytime I bet with too much size, I’m unwisely placing my profitability in the hands of too few trades. One or two missteps is all it takes to upset the profit cart. And indeed I have done so with my recent VXX adventures.
Fortunately, I’ve banished the demon of undiscipline from my domain and will remain ever wary lest he return to pilfer from my stash yet again.
{ 2 comments… read them below or add one }
Hey Tyler,
Why did you short VXX, instead of using options, for instance deep in the money put options which might cost a bit more but have limited risk and more leverage for the aggressive trader?
Barring that, why didn’t you trade XIV which should perform as well as a short VXX position (or better, as a gain of 10% two days in a row would be 21% and a loss of 10% 2 days in a row would be 19%)?
Hi Baruch,
In hindsight I wish I would have taken the long put route, so I agree with your sentiments there. Though, the appeal for me would have come from the limited risk aspect, not the leverage. I would had made money plenty quick enough on the short shares to make the leverage inherent in a put option unnecessary.
I’m not as familiar with XIV and have found VXX to be an effective enough vehicle when playing volatility.