Does a Foolproof First-Quarter Anti-Volatility Trade Exist?

The following is a reprint of the market commentary from the January 2018 edition of The Option Advisor, published on December 22. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.

With a new calendar year nearly upon us, Schaeffer's Quantitative Analyst Chris Prybal recently compiled detailed seasonality stats on a list of over 60 exchange-traded funds (ETFs) and indexes. While there was, understandably, quite a bit of data to review and digest, one anomaly jumped out -- an apparent pattern of first-quarter outperformance by an ETF built to track the daily inverse of short-term S&P volatility. Among all 60-plus tickers on Prybal's list, the ProShares Short VIX Short-Term Futures ETF (SVXY) boasted some of the strongest average monthly returns during the months of January, February, and March (looking at all monthly returns since inception).

This historical precedent of strong first-quarter returns is compelling in part because -- given that SVXY is structured to deliver the inverse of the daily returns of short-term CBOE Volatility Index (VIX) futures -- ProShares specifically prescribes against longer holding periods, and recommends daily management of positions. But the first-quarter outperformance registered by SVXY was intriguing enough to prompt a further investigation into the historical returns -- including back-testing a few option strategies to see if there's any reliable way to capitalize on SVXY's first-quarter strength.

Per the table below, note that March boasts the strongest average SVXY return of any month, with a somewhat improbable 100% of those returns being positive. You can see how, building on the very respectable average gains logged in January and February, the blockbuster March performance by this ETF has been a key contributing factor to the robust first-quarter results.

Drilling down further to isolate the individual monthly returns for each year, we find that January has been a volatile month for SVXY in the past six years, with results split between three double-digit percentage losses and three double-digit gains. February is comparatively quiet, with five of the six returns firmly in single-digit territory (but four of the six positive). And then there's the March line-up of positive returns -- two in the single digits, with the remaining four split between hefty jumps in the neighborhood of 15% and 37%.

Monthly returns that outpaced SVXY's "anytime" 21-day average for that respective year are bolded in the table below. March boasts a near-perfect record on this front, save for one near-miss in 2014.

Likewise, the summary of monthly returns below confirms that March is a beyond-standout month for SVXY. Not only has the ETF outpaced its typical monthly average return, median return, and percent positive, but it's also somewhat less volatile than usual, as measured by the standard deviation of returns. Conversely, January is considerably more volatile than most other months, with only a 50% shot at a positive return (despite the downright unassuming average and median returns for this month).

Of course, the most pressing question from a trading perspective is: How do we exploit SVXY's first-quarter performance? Schaeffer's Senior Quantitative Analyst Rocky White constructed some theoretical options trades to find out. In the table below, you'll see the results for at-the-money SVXY March calls, puts, and straddles, all bought to open on the final trading day of the preceding year, and closed at intrinsic value on March expiration day.

There's no clear "winning strategy" here, although -- as might be expected -- straightforward SVXY put purchases have fared the worst, with three 100% losses among the group. Also unsurprisingly, the call purchases have delivered the biggest percentage gains of 361% (just this year) and 220% (back in 2013). Both of those big call winners coincided with double-digit rallies for SVXY from the start of the year into March expiration. Also worth noting is that the straddle strategy has delivered more losers than winners, but not a single 100% loss -- so we certainly can't accuse SVXY of being stagnant during this time frame.

But perhaps the March expiration date was cutting us off at the knees here. After all, it's the full 31-day stretch that delivers the outsized average returns detailed above -- and due to the way the calendar falls, March options expiration has more often than not landed squarely in the middle of the month during the past five years.

So, White pulled returns for all three strategies again, but this time purchased an April-dated option on the final day of February, then closed it out the final day of March -- giving us a "pure" play on SVXY's most supercharged month of positive returns. Additionally, this approach essentially clears the field of 100% losses in every category, given that the trades would be closed out with several weeks of time value remaining.

The call returns here are impressive, with three of the five emerging as winners -- ranging from "healthy" in 2013 and 2017 to "knocking the cover off the ball" in 2016. And the losses for the call play are fairly palatable, too, with this hypothetical trader losing no more than half his investment in the "worst-case scenario."

The straddle, meanwhile, was a near-total bust. Only one winner was generated, in 2016, when the massive call gain was sufficient to offset the put option's implosion. Similarly, the put strategy was an unmitigated disaster (with the aforementioned 2016 "implosion" yielding the closest we came to a total loss in this round of theoreticals).

Of course, the usual caveats apply here -- we're looking at a small sample size of returns, given SVXY's relative youth, and your results may vary quite a bit with a more active trade management style (versus our admittedly quixotic search for a "set it and forget it" option trade). But we can say with confidence that the true "no brainer" play here is to avoid buying SVXY puts ahead of March -- and for those seeking a more "actionable" move, an SVXY call purchase timed to coincide with historical March strength in the ETF offers a higher probability of gains than losses.

That said, one final caveat for prospective SVXY call buyers would be to watch the VIX closely during the early innings of 2018. The results outlined above were generated during the current, years-long "low VIX regime" -- so if volatility in the stock market begins to ramp up into a higher range, the fund's March winning streak may lose its "sure thing" status.