UVXY is an ETF that targets 1.5x the daily returns of a 30-day constant-maturity position in VX futures – the SPVIXSTR index. Before 2018, it targeted 2x returns – but Volmageddon ruined the fun.
UVXY has to trade every day:
- To rebalance its notional exposure back to its target due to:
- Movements in VX, and
- Expense fees and trading costs being deducted from AUM.
- To maintain its target maturity of 30 days to expiry.
Anyone can trade UVXY in the market, and it trades close to the index because of an arbitrage in the ETF creation/redemption process (this is available to so-called Authorised Participants).
In this article, we’ll model some UVXY trading strategies in Excel:
- Short and rebalance
- Short a basket of UVXY and SXVY (another ETF targeting -0.5x returns) to harness tracking error
To keep things simple, I won’t include trading or short borrow costs, which are important inputs and will significantly impact both trades (and very likely kill the tracking error trade altogether).
First steps
This analysis uses this Excel spreadsheet, which you can download.
It includes historical price data for UVXY and SXY.
Here’s a plot of the UVXY price normalised to start at one:
The only real take away is that UVXY loses money quickly!
Here’s the log of the UVXY price instead:
You can see that it loses money consistently but occasionally explodes to the upside – just as we’d expect from a leveraged volatility fund.
Short that thing
Of course, when we see a chart like that, our instinct is to short the hell out of it.
And that’s a sensible thing to do, on average.
But it’s a trade that can blow you up when volatility spikes, so it needs to be managed at a sensible size and rebalanced aggressively.
To explore the impact of rebalancing frequency, navigate to the tab “1. UVXY short”.
Enter your target position in dollars and the rebalance frequency in the green cells.
Here’s what monthly rebalancing looks like:
The trade makes money but gets absolutely belted during Volmageddon and at a few other times.
The chart on the right is the actual value of the position. You can see that it got to 7x the target position size at one point – hello margin call.
Weekly rebalancing keeps things more under control:
And daily rebalancing even more so:
Of course, just because you’re checking in once a day is no guarantee you won’t get belted in this trade, so it always needs to be sized sensibly.
There’s also a trade-off – the more frequently you rebalance, the more you pay in trading costs, which aren’t modelled here (although you could extend the spreadsheet if you wished).
Tracking error alpha
Consider a strategy that seeks a VIX-neutral position by maintaining constant short exposure to SVXY and UVXY in the correct proportions.
Such a VIX-neutral exposure will isolate the tracking error. It will make money to the extent that the ETFs don’t hit their target exposures – which is more likely to happen on big moves.
Of course, short borrow costs will have an impact on this strategy, and they’re not included here. Note also that in the analysis, we need to account for the fact that both ETFs changed their leverage in 2018.
To model this strategy, navigate to the tab called “2. Short SVXY+UVXY”. As before, enter your total target exposure and your rebalance frequency.
Here’s what it looks like:
You can see that this used to be a more attractive trade, but it seems that today, these ETFs track their targets more efficiently.
Both ETFs got downgraded to a lower leverage target after Volmageddon, and the trade basically stopped working at that time.
Conclusions
Leveraged volatility ETFs provide interesting trading opportunities. While UVXY can still be used for short volatility exposure, borrow costs are a factor, and the trade will need to be rebalanced aggressively.
The tracking error strategy died after Volmageddon.
Excel is a fantastic tool for modelling simple strategies in a visual manner that allows interaction with the data.
