Original paper

SSRN-id2792358.pdf1218.0KB

Trading rules

Investment universe: 60% SPDR S&P 500 ETF Trust (SPY) and 40% iShares 7-10 Year Treasury Bond ETF (IEF)
Allocate 0-100 basis points (bps) to VIX call options
Purchase VIX call options at 135% moneyness of underlying VIX futures price
Systematically buy equal amounts of 1-month, 2-month, 3-month, and 4-month VIX call options on VIX futures
VIX Index between 15 and 30: 1% weight in VIX calls
VIX Index between 30 and 50: 0.5% weight in VIX calls
VIX Index above 50 or below 15: 0% weight in VIX calls
Roll options to appropriate expiry the day before expiration each month
Purchase VIX call options at offer price, sell at bid price
Hold options until maturity, close positions Tuesday afternoon before Wednesday morning of VIX futures and options expiration
Sell contracts with intrinsic value at bid price, use cash to rebalance stock/bond portion of the portfolio at month’s end

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.

A Study in Portfolio Diversification Using VIX Options

Original paper

Trading rules

Python code

Backtrader