Original paper
Abstract
The search for dependable, low-cost portfolio tail protection or hedge from exogenous events such as the 1987 crash, the 2000 dot-com bubble, the 2008 credit crisis, and the 2011 European crisis continues. This study assesses the performance of a systematic VIX call buying strategy with a defined cost to hedge an equity portfolio from systemic risk. A portfolio manager must weigh these costs against those of hedging strategies that have potentially undefinable costs, for example, protective puts or shorting equity index futures. The analysis shows that a passive allocation to VIX calls has proven effective in large drawdown periods and can be accomplished by spending a relatively small defined percentage of capital when the hedge is not needed. The study applies a set of fixed rules to empirical data with the goal of optimizing ex-post the moneyness and expiry of VIX call options over the period studied. For the period of analysis, the systematic purchase of properly placed VIX calls tends to provide sufficient protection in tail risk events for minimal cost when hedging is not needed.
Keywords:Â VIX, Call Options
Trading rules
- Base investments on: 60% allocation to SPDR S&P 500 ETF Trust (SPY) and 40% allocation to iShares 7-10 Year Treasury Bond ETF (IEF).
- Allocate anywhere from 0 to 100 basis points (bps) to VIX call options.
- Buy VIX call options at a moneyness of 135% based on the VIX futures price.
- Consistently divide your investment equally across VIX call options with expiries of 1, 2, 3, and 4 months.
- If VIX Index lies between 15 and 30: Dedicate 1% of the portfolio to VIX calls.
- If VIX Index ranges between 30 and 50: Dedicate 0.5% of the portfolio to VIX calls.
- No allocation to VIX calls when VIX Index surpasses 50 or is under 15.
- Roll options to their appropriate expiration a day before their expiry every month.
- Purchase VIX call options at offer price, sell at bid price.
- Retain options up to their expiration and close positions on Tuesday afternoon, preceding the VIX futures and options expiry on Wednesday morning.
- Liquidate contracts with inherent value at their bid price and utilize the proceeds to adjust the equity/bond segment of the portfolio at the close of the month.
Python code
Backtrader
import backtrader as bt
import datetime
class VIXHedgingStrategy(bt.Strategy):
params = (
('spy_allocation', 0.6),
('ief_allocation', 0.4),
('vix_call_weight_low', 0.01),
('vix_call_weight_high', 0.005),
('vix_lower_bound', 15),
('vix_upper_bound', 50),
)
def __init__(self):
self.spy = self.datas[0]
self.ief = self.datas[1]
self.vix = self.datas[2]
self.vix_futures = self.datas[3]
self.vix_call_options = self.datas[4:8] # 1-month to 4-month VIX call options
def next(self):
# Determine VIX call options weight
vix_call_weight = 0
if self.vix[0] > self.params.vix_lower_bound and self.vix[0] <= 30:
vix_call_weight = self.params.vix_call_weight_low
elif self.vix[0] > 30 and self.vix[0] <= self.params.vix_upper_bound:
vix_call_weight = self.params.vix_call_weight_high
# Allocate to SPY and IEF
self.order_target_percent(self.spy, self.params.spy_allocation)
self.order_target_percent(self.ief, self.params.ief_allocation)
# Allocate to VIX call options
if vix_call_weight > 0:
for option_data in self.vix_call_options:
option_price = option_data.close[0] * 1.35 # 135% moneyness
option_value = self.broker.getvalue() * vix_call_weight / len(self.vix_call_options)
option_size = option_value // option_price
self.buy(data=option_data, size=option_size)
# Roll options and rebalance the day before expiration
if self.datetime.date() + datetime.timedelta(days=1) == self.vix_futures.expiredate[0]:
for option_data in self.vix_call_options:
self.close(data=option_data)
self.rebalance()
def rebalance(self):
cash = self.broker.get_cash()
self.order_target_value(self.spy, cash * self.params.spy_allocation)
self.order_target_value(self.ief, cash * self.params.ief_allocation)
cerebro = bt.Cerebro()
# Add data feeds for SPY, IEF, VIX, VIX Futures, and VIX call options
# ...
cerebro.addstrategy(VIXHedgingStrategy)
cerebro.run()This code provides a skeleton for implementing the VIX hedging strategy in Backtrader. Please note that you’ll need to add the appropriate data feeds for SPY, IEF, VIX, VIX Futures, and VIX call options in the specified order. Also, ensure that the VIX call options data includes bid and ask prices for accurate trading.