Our portfolio management system is built around the philosophy of owning market protection only when “crisis” or bear market conditions are present in the VIX marketplace. This results in portfolios that tend to do best while the VIX is either over 20 (bear markets) or under 18 (bull markets), two zones together accounting for 90% of VIX Index closes since its inception in 1990 (see chart below).

*VIX Index Phase History 1990-2019. Source: TCM. Click for larger image*

Referencing price levels might imply a purely directional cause-and-effect, but the decay element of VIX contracts also makes time a major factor in their price movement, especially when decay is strongest: under 18 or over 20 in the VIX index. For our strategies, the bottom line is that the longer the VIX Index spends in either zone, the more likely it is that a given position will be profitable. This is most easily observable in Alpha Seeker’s market-beating return during 2017 while the VIX index remained below 18 for the entire year, or over the past 8 years when 78% of VIX closes have been under 18. This is very common behavior for the VIX during bull markets and is beneficial for inverse VIX or long S&P exposures while it persists. On other end of the spectrum is the situation seen only in brief flashes since Alpha Seeker’s inception, when long VIX positions benefit while the VIX clusters above 20– common during crisis periods and bear markets in equities (red bars in the chart above). Perhaps the “gold standard” of this type of environment was during the Financial Crisis in 2008 when nearly 90% of that year’s daily VIX closes were over 20 as the VIX averaged 32.69 for the year. In 2008, the S&P 500 lost a shocking -37% while the Alpha Seeker strategy posted the best year in its backtest period (+41%).

This leaves the relatively rare VIX index readings between 18 and 20 which have historically clustered around transitions between bull and bear markets (yellow bars in chart above). During these periods, the decay factor in VIX contracts is often overwhelmed by increasingly erratic movements in the VIX Index, effectively turning VIX positions into a low-odds directional play on the VIX Index. Beyond the mirage of a year-to-date return calculated from the bottom of a sharp “V”, this describes the period since Jan 2018 well. As recently as Oct 3rd, the stock market had returned less than T-Bills since the market peak in Jan 2018 as the VIX index has increasingly tested and retreated from the “bear market zone”, crossing the 18-20 threshold an astounding 25 times in 2019 alone. Reflecting the volatility of the VIX and the lack of consistent decay described above, since Jan 2018 nearly every VIX ETF and ETN, long or short, has posted a loss. This is the behavior of a market between bull and bear phases.

While a bear market is certainly not guaranteed, the odds of one are now objectively as high as they’ve been since 2007 (see NY Fed Recession Probability). Adding to the risk for investors, the most attractive recent returns in this environment have been from passive indexes which by definition provide no protection against a bear market. This presents a conundrum for advisors who may feel compelled to choose between protecting or keeping their clients, or for investors torn between the fear of missing out and the fear of a market decline. As advisors and investors facing the same challenges, we set out to design strategies that offer a better compromise– visit our strategies pages to learn more.