The document discusses using the CBOE Volatility Index (VIX) to develop trading strategies for assets like the SPDR S&P 500 ETF Trust. It provides steps to backtest a long/short strategy using the Bloomberg Professional platform. Testing a strategy that was long when VIX crossed above 40 and short when below 10 from 2000-2014 would have yielded a 193% return compared to 48% for a buy-and-hold approach. Parameter optimization can help identify strategies with even higher returns, like being long above 30 and short below 31 for a $644,180 return.

1. STRATEGIES EQUITIES
98
WALL STREET’S FEAR gauge was all but dead last
summer, dropping to a seven-year low in early July.
By October, the VIX Index had tripled as shares
tumbled on fears of Ebola and sectarian violence
in the Middle East.
The Chicago Board Options Exchange Volatility
Index, as the gauge is formally known, rises when
U.S. stocks fall, and it topped out at 31.06 on Oct. 15,
a three-year high. The number translates to an an-
nualized percentage point change in the Standard
& Poor’s 500 Index during the next 30-day period.
THE HIGHEST VIX readings occur when inves-
tors anticipate huge moves, either up or down, in
equities. Its peak during the past decade was 89.53
on Oct. 24, 2008, a month after Lehman Brothers
Holdings Inc. filed for bankruptcy.
Elevated readings usually occur after a market
selloff, while low levels are typically seen amid
a rally. Investors can use the VIX to analyze the
trading history of stocks and come up with buy
and sell triggers. A hypothetical long-and-short
strategy derived by backtesting and optimization
tools on the Bloomberg Professional service de-
livered a profit of 193 percent from Jan 1, 2000,
to Nov. 26 versus a 48 percent return with a buy-
and-hold approach.
To demonstrate this, first type BT <Go> for the
Advanced Backtesting & Optimization function
and click on New Strategy on the red tool bar. On
the next screen, enter SPY in the security field in
the upper-left corner of the screen and select the
first option in the list
that appears: the SPDR
S&P 500 ETF Trust,
the largest exchange-
traded fund tracking
the benchmark index.
Click on Add Se-
curity/Datafield
and then on the
box to the left of
Use Additional Se-
curity so that a check
mark appears. Enter
VIX in the SECURITY
field and select the first option in the list that ap-
pears. Enter VIX in the NAME field. In the FIELD
field, enter LAST and select Last Price from the list
that appears. Then click on Update.
Now, let’s create some parameters for the VIX.
Click on Add Variable. In the pop-up screen, enter
40 in the VALUE field and then click on Update.
Go through the same steps to add another variable
with a value of 10. We’ll create the trading strategy
by defining our rules. Click on Add Rule in the cen-
ter left of the screen. Click on the first arrow under
Action and select Cover and Go Long. Select When
under Qualifier, if it isn’t already selected. Click on
the arrow to the right of When and select VIX. Un-
der Condition, select Crosses Above. Click on the
arrow to the right and select Variable1, which rep-
resents our high threshold of the VIX, at 40.
Click on the second arrow below Action and se-
lect Close and Go Short. Going left to right, select
Trading the
Fear Index
TypeVCA
<Go> fordata
onvolatilityand
correlation.
TypeBT <Go> totesttrading
strategiesforassetssuchas
theSPDRS&P500ETFTrust.
BY IAN McFARLANE

2. 99
Ian McFarlane is a technical analysis specialist at Bloomberg in London.
Imcfarlane1@bloomberg.net
When it’s done, click anywhere on the row of the
strategy to bring up a data table showing results
for all its different permutations. Click on the
Total column under Profit (Loss) to order the strat-
egies by returns.
The optimal strategy returned $644,180, which
was achieved by going long when the VIX crossed
above 30 and going short when it crossed below 31.
If we run the same strategy on a short-term ba-
sis, using intraday 30-minute data over one year,
we get different results for
the optimal long and short
triggers. In 2014 through
Nov. 26, the most profit-
able strategy delivered a
$25,380 return after going
long when the VIX crossed
above 21 and going short
when it crossed below 11.
To create alerts, type
BT <Go> again and click on
the bell icon in the row of
a strategy’s name. You can
configure the alert to send
you a message or pop-up
when the conditions of
your strategy are met.
As the saying goes, past
performance is no guarantee of future returns.
That said, these tools can help you take a gut
instinct about how market forces interact and turn
it into an actionable strategy.
When, VIX, Crosses Below
and Variable2, which is our
low mark for the VIX, at 10.
Enter a name in the STRAT-
EGY TITLE field and click
on Save on the tool bar.
Taken together, these
two steps tell you to buy the
SPDR ETF when the VIX is
high, which is likely to oc-
cur during a sharp sell-
off, and to sell when the
gauge has calmed down,
when prices are apt to be at
a peak. To see how this method would have done
historically, change the start date at the top of the
screen to 01/01/2000 and then click on the Strat-
egy Analysis tab.
THIS PLAN WOULD have delivered a profit of
$192,740 through Nov. 26 on an investment of
$100,000. (You can edit the initial capital in the
Simulation Control tab.) Going back through the
steps and testing a simple long-only strategy shows
the profit would have been just $48,250.
Is it possible a different set of rules would have
worked even better? To test this, click on Launch
on the tool bar and select Parameter Optimization.
Under Selected Parameters for Variable1, enter 5 in
the MIN field and 50 in the MAX field. Do the same
for Variable2 and click on Submit Optimization on
the red tool bar. In the pop-up window, click on
View All Optimizations.
It may take a minute or so for the function to
complete the calculations. You can check on the
progress by clicking on Refresh on the tool bar.
TheOptimizationAnalysis
tabdisplaysresultsfor
allpossiblevariationsof
yourstrategy. TypeHS
<Go> tosee
thehistorical
spreadoftwo
assets.
FEBRUARY 2015
BEST RESULTS
Click on Total to
rank the variations
by their return.
Usethe
optimizationtool
touncoverthe
bestparameters
foryourstrategy.