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The Fundamental Strangeness Of VIX Futures

(i have found a copy of the article in my cache - unfortunately, I am unable to bring back my colleagues comments)

The whole futures curve of VIX has been trading at a higher premium to "spot" than usual - a kind of iv effect, I suppose: perhaps the last spike really scared people, or maybe it's Ukraine.

This is more paradoxical than usual, but even the usual (when there is less of a futures premium on VIX) is paradoxical: VIX itself is calculated from the relative prices of calls and puts on the S&P, which themselves reflect market participants expectations of the future. There is implied volatility built into those options. Elevated VIX futures prices therefore mean that VIX futures traders build additional implied volatility into their estimate of future volatility and this perforce goes to zero at expiry because VIX futures are cash settled - yes - but based on the price of the S&P options strip at expiry. ("The final settlement value for VIX futures shall be a Special Opening Quotation (NYSEMKT:SOQ) of VIX calculated from the sequence of opening prices of the options used to calculate the index on the settlement date. Etc." See here).

This seems to create an opportunity for arbitrage for a well capitalized fund. Long the strip, short the future. If one could figure out a way to hold some version of VIX spot, the trade would be similar to writing a covered call but better - and risk free. The trade would be placed for credit and the credit would be equal to cost of underlying plus time value built into the future (the amount of the contango). 1 month contango usually runs 3 to 6 percent. Hard to believe no one has thought of that?

The difficulty lies in not being able to hold VIX itself and perhaps in it being impossible to construct a combination of S+P options that reflect it; or, if such a position is possible to construct, perhaps in having to constantly roll it thus incurring a profit-destroying cost. A simpler strategy might perhaps be to long S+P options and short VIX via VIX ETF derivatives.