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Short Volatility with Two Ways to Potentially Win



October 12, 2017

Depending on the type of volatility environment we find ourselves in, success in being long the short-term VIX futures exchange traded products (“ETPs”) will derive from a different source of edge.

Generally speaking, when volatility (and the VIX) is low, we can take advantage of the structural edge in the term structure of the VIX futures curve itself. I call this more of an “inherent mechanical” source of edge that is favourable around 80-85% of the time when the shape of the VIX futures curve is found in contango.

In these times of relative calm, VIX futures aren’t shifting significantly lower. However, the negative daily roll-yield from the rolling futures translates into a roll-to-a loss for the long VIX futures ETPs, and a gain respectively for the short products.

Conversely, when volatility is high, we may face drawdowns in the short term from futures resetting at a higher level. In this circumstance however, we are betting on a different kind of edge: human nature and the propensity for relative option pricing to revert to the mean. Stocks can stay down but volatility has a very difficult time staying up. This is because markets and investors have an uncanny ability to digest whatever prevailing worry exists.

We have seen markets grapple with just about every kind of curveball imaginable – from the U.S. debt ceiling and political dramas, to all varieties of geopolitical risk. Over time, the negative influence is solved, dissipates or investors simply get used to it. I believe that because we are human, as investors we try to look at the bright side of things. For these reasons, playing the short side of the volatility ETP trade is usually the winning one over time, regardless of the VIX regime.

There are two ways you can win: 1. via structural edge from negative roll-yield and high volatility risk premiums; or 2. from high levels of fear that invariably deplete themselves naturally. In the volatility world, more often than not, what goes up must come down.

The views/opinions expressed herein may not necessarily be the views of AlphaPro Management Inc. and Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

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