Here are a few histogram plots in response to a post on Sanz Prophet’s blog:
The plots show SPY returns after buying VIX lows (similar to buying SPY breakouts) then selling on expiry (Opex). Only one trade loses more than 6%, confirming Sanz’s comment regarding tail frequency. Buying VIX highs are shown for comparison.
The tighter distribution makes perfect sense: VIX is a 1 month forward volatility forecast (evidently a very good one). Therefore 1 month SPY returns are expected to cluster tightly after VIX lows. Options prices include forecasted volatility, thereby ensuring efficiency (no free lunches – see next post).
Buy SPY on VIX 20 day high, sell at opex (average trade 16 days):