Trading VIX Futures under Mean Reversion with Regime Switching

TL;DR

This paper develops a regime-switching mean reversion model for optimal VIX futures trading, analyzing timing strategies and the effects of transaction costs through numerical methods.

Contribution

It introduces a novel regime-switching framework for VIX futures trading and provides a numerical solution approach for the associated optimal stopping problems.

Findings

Optimal trading boundaries are characterized under regime switching.

Transaction costs significantly influence trading strategies.

Regime timing impacts the effectiveness of VIX futures trading.

Abstract

This paper studies the optimal VIX futures trading problems under a regime-switching model. We consider the VIX as mean reversion dynamics with dependence on the regime that switches among a finite number of states. For the trading strategies, we analyze the timings and sequences of the investor's market participation, which leads to several corresponding coupled system of variational inequalities. The numerical approach is developed to solve these optimal double stopping problems by using projected-successive-over-relaxation (PSOR) method with Crank-Nicolson scheme. We illustrate the optimal boundaries via numerical examples of two-state Markov chain model. In particular, we examine the impacts of transaction costs and regime-switching timings on the VIX futures trading strategies.