Holding this volatility pair through October

At the end of September, I resumed my short Barclay’s Bank iPath S&P 500 VIX Short-Term Futures (VXX) – long Barclay’s Bank iPath S&P 500 VIX Mid-Term Futures (VXZ) strategy.  Mid-term VIX futures (VXZ) were less elevated and provided a better hedge for VXX.  I will hold this pair through October as long as mid-term VIX futures do not rise significantly higher than short-term VIX futures.

As I highlighted in my August commentary, I will maintain short VXX / long VXZ positions as long as the average of the fifth and sixth-month VIX futures does not rise more than 35% above first- month VIX futures.

VXZ does not effectively hedge VXX when VIX futures ratios are above 35%, due to the following:

a) Short-term VIX futures tend to be below their mean-reverting level but
b) Mid-term VIX futures tend to be at least equal to their mean-reverting level
c) Impact from combining a) and b) is short-term VIX futures tend to rise while mid-term VIX futures stay constant

Therefore, if this ratio exceeds 35%, then I will switch back to a short VXZ position.

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