Volatility Targeting Backtest

Volatility Targeting is designed to keep SPDR S&P 500 ETF Trust (SPY) exposure responsive to changing market risk by scaling exposure down when volatility rises and up when volatility falls.

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Strategy summary

Volatility Targeting is a risk-control strategy built to pursue smoother equity participation from the premise that exposure should contract when realized volatility rises and expand when realized volatility falls, using daily SPY volatility scaling with a synthetic SHY cash/financing proxy.

The strategy uses the higher of 20-day and 60-day realized volatility estimates, computed from daily SPY log returns and annualized with 252 trading days. The resulting exposure is capped at 150% of equity and is applied at the next session open. A 5% turnover buffer prevents small leverage changes from forcing a rebalance.

When the target exposure is below 100%, the difference is represented by a synthetic iShares 1-3 Year Treasury Bond ETF (SHY) cash / financing proxy. When target exposure is above 100%, the negative cash weight represents the strategy’s financing leg. SHY is not traded as a separate sleeve; SPY is the only traded strategy security.

What this strategy is not

• Not a market-timing model that exits equities based on trend direction.
• Not a no-leverage 0–100% exposure cap; SPY exposure can rise above 100% and is capped at 150%.
• Not a short-selling or traded-SHY strategy; SHY is a synthetic cash / financing proxy, not a separate traded sleeve.
• Instead: a daily SPY exposure-scaling overlay designed to keep portfolio risk closer to a fixed volatility target.

Report summary

Benchmark summary

The primary benchmark is buy-and-hold SPY. This is the cleanest control because it preserves the same core risky asset while removing the volatility-targeting overlay.

For the benchmark-selection framework, see How to Choose the Right Benchmark.

• Primary Benchmark: SPY buy-and-hold.
• Preserves: the same U.S. equity ETF exposure represented by SPY.
• Removes: the daily volatility estimate, exposure-scaling rule, leverage cap, turnover buffer, and SHY cash / financing proxy leg.
• Excludes: SHY, 60/40 portfolios, risk-parity portfolios, and published risk-control indexes, because those change the comparison object or add a second thesis.

Key metrics: 2021–2025 free preview

• The free preview is a recent-window orientation tool, not the complete evidence set.
• A five-year free-preview window can be useful, but it can also overstate or understate the full historical tradeoff.
• The full report expands the scorecard across the complete report window and adds the path-level interpretation behind the headline numbers.

In this five-year free preview, Volatility Targeting kept risk lower than SPY buy-and-hold but still trailed on growth. The strategy compounded at 8.5% with a $15,024 rebased ending value, while the benchmark compounded at 14.7% and ended at $19,791.

Further research

• BTS Methodology
• What Makes a Backtest Reliable?
• Why a Standardized Methodology Matters in Backtesting
• How to Choose the Right Benchmark
• Strategy Library