The 24-page BlackRock paper “VIX Your Portfolio – Selling Volatility to Improve Performance” (June 2013 ) recommended exploring the possibility of selling futures on the CBOE Volatility Index® (VIX®), collateralized with Treasury bills, and the paper noted that –
“A strategy that systematically sells volatility on a diversified equity index should capture a positive risk premium over long horizons because it is similar to selling insurance. … (With the selling of VIX futures) we find a historically higher returning strategy with a smaller drawdown, compared with buying equities.”
CBOE BENCHMARK INDEXES – VPD AND VPN
While the BlackRock paper used a methodology to simulate the performance of a strategy that sells VIX futures, CBOE also offers a couple of benchmark indexes designed to mimic strategies that sell VIX futures –
- The CBOE VIX Premium Strategy Index (VPD) holds 3-month T-bills, and sells 1-month VIX futures (the number of VIX futures sold at each roll is set to preserve 75% of the initial value of the portfolio in the event that VIX futures increase by 25 points).
- The CBOE Capped VIX Premium Strategy Index (VPN) holds 3-month T-bills, and sells 1-month VIX futures; the short VIX futures position is capped with long VIX calls struck 25 points higher than the VIX futures price.
Below are two price charts that show the re-scaled performance of select indexes in the period from June 30, 2004 through August 30, 2013. Of the seven indexes shown on the two charts, the top two indexes in terms of total returns were the VPD Index (up 132%) and the VPN Index (up 129%). As a cautionary note for the strategy of selling one-month VIX futures, in 2008 the VIX Index rose 77.8%, the VPD Index fell 44.9% and the VPN Index fell 35.8%. Remember that both indexes hold Treasury bills. In 2012 the VPD rose 37.1% and the VPN rose 34.2%.
MORE ON THE CONSTRUCTION OF THE VPD INDEX
Here is more information on the construction of the CBOE VIX Premium Strategy Index (VPD). At the close of June 15, 2004, the inception date, $100 was invested at the three-month Treasury bill rate. On June 16, 2004, the first roll date, VIX futures were sold at the opening bid price of VIX futures. From thereon, the VIX futures were marked-to-market daily at the close and the resulting cash flow is credited to or debited from the opening money market balance. At the next expiration, July 14, 2004, the futures position was settled at the open to the final settlement price, and new VIX futures were sold at the opening bid price. The cash flows from the final mark of expiring contracts and from the daily closing marks of the new contracts are financed from the money market balance. This process is repeated from expiration to expiration.
One of the reasons that the VPD Index generally has done well in in the past year is the fact that the CBOE Volatility Index (VIX) usually has been in contango in the past year; contango is a situation during which the futures price (or forward price) of the underlying instrument is higher than the expected spot price. However, if the VIX were to experience a substantial rise in the future, the VIX could go into backwardation and the VPD could experience a fall.
For information on more than ten CBOE benchmark indexes (including VPD and VPN) please visit www.cboe.com/benchmarks