Today I will share with you new research to trade volatility, especially the VIX ETN, which is the VXX.
Common lore is that implied volatility increases ahead of a long holiday weekend. This supposed increase in implied volatility is due to investors and traders buying insurance to protect themselves from the unknown of the upcoming 3 days.
We decided to test this out with the idea of buying the VXX the day before the holiday weekend and then selling it on the next day. Therefore if the holiday weekend started on the close of business on Friday, we’d buy the VIX on the close on Thursday in anticipation of insurance being purchased that Friday. What we found was the exact opposite of what is commonly thought.
From 1995 through April 30, 2009, there has been 75 three-day weekends.
If you had bought the VIX on Thursday’s close in anticipation of volatility rising the day ahead of the weekend, you would have been correct 33% of the time. That means the volatility has dropped 2/3rds of the time the day before a holiday weekend, not risen. On average the VIX has lost 1.53% for those 24 hours leading into the 3 day weekend.
One could not trade the VIX outright over this period of time. But you can now trade the VXX which is based upon the price of the VIX futures. They trade fairly actively most days and are fairly liquid.
The bigger lesson from today is not to go in and buy the VXX on this Thursday’s close. It’s more important to understand that there are many pieces of folklore that make their way through Wall Street (things like oscillator divergences) that traders believe to be true. Some are true, and many are not. The key thing to do is when you have an indicator or a strategy that supposedly works because it’s mentioned in a number of books and trading articles is to test it first. As you can see from the example above, the common idea that volatility increases ahead of a three-day holiday weekend has not been true the majority of time in the past 14+ years. Quantify, Quantify, Quantify!
This is from Larry Connors Daily Battle Plan which he publishes each morning. If you’d like to take a free trial click here, or call 1-888-484-8220 ext. 1 to start your free trial today.
Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.