TuringTrader's VIX Treasures

Strategy Rules

The operation of VIX Treasures can be summarized as follows:

• invest in the S&P 500, with exposure scaled inversely to 1-month implied volatility
• measure volatility relative to 12-month implied volatility
• invest up to 50% of unused capital in U.S. treasuries
• invest any remaining capital in the aggregate U.S. bond market

These rules reflect the idea that in the long run, the U.S. stock market provides the best growth opportunities. Volatility poses the biggest threat this growth, which is addressed through reducing exposure in periods of elevated volatility. Volatility is measured by the slope of the VIX term structure. While usually in contango, the VIX enters backwardation in times of market turbulence.

We encourage investors keen on learning more about this rationale to read our article regarding volatility targeting.

Diversification

The strategy is well diversified in terms of individual titles, as it only invests in broad indices. VIX Treasure's low beta suggests the strategy is also well-diversified across asset classes. However, in times of low volatility, the strategy may allocate up to 100% of the capital toward the stock market, leaving some tail risk in case of rapidly spiking volatility.

Returns & Volatility

Like many active strategies, an essential part of returns stems from losing less than passive portfolios during recessions. Therefore, VIX Treasures achieves the stated goal only over the full economic cycle.

VIX Treasures beats a passive 60/40 in most years and has shown docile behavior throughout the last economic cycle. The portfolio managed the 2008 recession very well, even though missing out on part of the 2009 rebound. The strategy’s average drawdowns are only slightly higher than those of a passive 60/40, while its maximum drawdowns are lower. Over the past economic cycle, VIX Treasures has beaten a passive 60/40 as well as the S&P 500 by a wide margin.

The Monte-Carlo simulation confirms these observations. VIX Treasures provides a significant upside over its benchmark, while showing lower risks.

Account & Tax Considerations

When the strategy scales its stock market exposure, it triggers taxable events. However, VIX Treasures holds at least 60% of its positions for several years. Therefore, VIX Treasures is a great candidate for taxable accounts, with a tax burden similar to a passive 60/40 portfolio.

VIX Treasures invests in no more than three ETFs at a time. Therefore, it can function adequately with as little as $5,000 of capital.