Followers of the VIX ETPs know full well the importance of paying attention to the VIX term structure. While movements in the VIX alone can't fully explain the returns one can expect from products like VXX, XIV, UVXY, and TVIX, when combined with an analysis of the term structure, you get a clearer picture of what exactly is going on with these products (not a perfect picture, just a less ambiguous one). For those familiar with bonds and the fixed income universe, the analogy I like to think of is duration and convexity for changes in interest rates. As a single point estimate, duration can be a poor indicator of bond performance over large changes in interest rates. However, duration combined with convexity can give one a reasonably better estimate on bond performance for large changes in interest rates. So too, when one combines movements in the VIX with the current VIX term structure, you arrive at a more robust explanation of VIX ETP performance over time.
And here follows below a set of visuals that combine the two biggest drivers in VIX ETP returns: the VIX itself and the VIX term structure. I've broken out by year since 2007 how the VIX term structure has distributed the number of trading days over the year by the difference in price of the front-month and third-month VIX futures contract. I use these two months in particular simply because the balance of products on the VIX focus on the front months of the term structure (followers of the term structure should be able to back out that, being as concave downward as it is, the term structure will have a lesser impact on the intermediate ETPs like VXZ and ZIV). On each chart, I've also shown the price change over the course of the year for both the cash VIX and also a buy-and-hold front-month VIX futures position (rolled the day before each expiration).
Just to clarify what you are looking at (this may appear hard to read at first...apologies), the bottom x-axis shows the degree of difference between 1-month and 3-month futures prices and goes with the left-hand y-axis that shows the number of trading days (the red bars) for various differences in the two futures prices. I've put a 0 line up where red bars to the left are negative (contango) and red bars to the right are positive (backwardation). The right-hand y-axis goes with the time series on the top x-axis and shows the change in VIX points over the year for the cash VIX (black line) and the front-month VIX future (blue line).
I find the data set to be interesting, because while the VIX term structure has an overwhelming propensity to be in contango, the distribution is not very uniform over time and can fluctuate wildly. I find that 2012 was probably one of the most extreme cases of the futures market in contango. It spent all of 1 day the entire year outside of contango conditions. Due to the severe degree of contango over the course of the year, 2012 represented essentially a volatility selling paradise of sorts, with only a minor blip in equity markets over the course of the summer last year. Bill Luby at VIX and More has done a similar piece looking at 2012′s term structure in comparison to the term structures of prior years. (If you are new to the VIX or in need of some insightful analysis on anything VIX-related, you need to check his site out.)
How has 2013 stacked up so far? Well it looks essentially like more of the same from 2012, if only to a lesser degree. Some might argue complacency in markets, and it could be a point well taken. In fact, you could argue that 2010 is an analog for what 2013 is shaping up to be. In that year, the VIX term structure was in steep contango for the first few months before the Greek debt crisis really came to the forefront and the flash crash followed not too long thereafter. However, despite all the market mayhem that followed afterwards (including a 1,000+ point intraday drop in the Dow), the term structure quickly came back to contango and on balance for the year was still a great environment for selling volatility despite the drama of the flash crash.
I guess time will tell if we can get a macro event able to tip this market over to the downside since we have already dismissed multiple threats to the current rally like sequestration and the ECB's handling of the banking crisis in Cyprus.