Tuesday, March 26, 2013

Easy portfolio setup for a 2.37 Sharpe Ratio

The CBOE VARB-X (Volatility Arbitrage) Strategy Benchmark has reached a Sharpe ratio of 2.37-- significantly greater than the Sharpe Ratio for the S&P 500 for the same time period, as seen in the below graph.

* Technically it is more of a statistical arbitrage, since it's an unhedged bet, though with a very positive expectation.

Some basic relative performance stats for the period:

Average Annual Return Standard Deviation
     VARB-X 19.00% 6.40%
             SPX 8.30% 10.30%

It is simple to replicate, by following the setup described in the Strategy Benchmark Paper.

1) Keep 80% of the portfolio cash.
2) Short and hold Variance Futures, roll with each expiration.

Ways to avoid the volatility spikes (drawdowns)

1) Apply a volatility filter
2) Use volatility forecasts for position size adjustment. You can do this in Excel, or off a 3rd party such as NYU V-Lab

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