More Strange Happenings in the VIX Term Structure

Includes: VIXX, VXX, VXZ, XXV
by: Bill Luby

Thursday was a very unusual day in the land of VIX futures. As the VIX futures term structure graphic below shows, the volatility futures moved upward at a rate that was roughly equal across the next eight expiration months.

With the front month VIX futures 45% above the lifetime average in the VIX, one would anticipate that expectations regarding mean reversion would significantly dampen the rise in VIX futures prices in the more distant expirations, much like the pattern I posted about two weeks ago and on many previous occasions. In fact, with the VIX this high, I don’t ever recall seeing the back month VIX futures keeping up with the front month futures in any substantial increase in the VIX.

If you are on the fence about becoming a survivalist and are looking for a sign, look no farther than the VIX futures, which are predicting daily changes in the S&P 500 index of more than 2% at least two out of every three days, starting in October and extending out at least as far as VIX futures are quoted, which is through April 2011. In order to reach their current January valuation, the VIX would have to rise more than six points (23%) in the next 4-1/2 months or so. Another way of looking at the expectations for a jump in volatility would be to consider that the current 20-day historical volatility in the SPX would have to double from the current level of 16.70 in order to make these VIX futures predictions pan out.

Between now and then, there are elections, Fed meetings, two earnings reporting seasons and countless economic data reports that will color the way investors look at the world.

With such a large difference between the current situation and how investors are pricing in future volatility, there are many intriguing trading opportunities. Apart from the usual suspects of VIX options, VIX futures and the VXX ETN, don’t forget VXZ, the iPath S&P 500 VIX Mid-Term Futures ETN, which targets VIX futures with a five month maturity, which translates to late January.

[As an aside, note that investors are pricing in lower volatility in December, due to the holiday season, just as had been the case for the August VIX futures, when traders were anticipating a relatively slow market due to the vacation season.]

(Click to enlarge)


Disclosure: Short VIX and VXX at time of writing