Market Volatility Bulletin: VX Term Structure Takes The Middle Ground

by: The Balance of Trade

Spot VIX nestles near 20 as US equities attempt to take back some of yesterday's losses.

Normalizing central bank policy is sure to have some errors in execution, but is absolutely a worthwhile undertaking.

The term structure sits between the low HV10 and the high HV20, seeming to take a "wait and see" approach.

Market Intro

CNBC: Wed, 10:17 AM EST

US stocks (SPY, DIA, QQQ, IWM) are managing a partial comeback after the bottom seemed to fall out in Tuesday trade. Strong earnings have the Dow in particular beginning the session with a bright open. Spot VIX tracks right around the 20 level.


Yields are up a couple basis points, but the overall yield curve remains quite flat. There appear to be fewer news stories about how the Treasury yield curve is about to invert, and how that necessarily means that the economy is in bad shape. At present, US yields are on the whole meaningfully higher than most counterparts throughout the developed world. Context matters.

Thoughts on Volatility

There is plenty of reason to believe that the trade scuffles between China and the US will ultimately be resolved without escalating into an all-out trade war, but that both parties will posture and put out test balloons before backing down. That means that a tidy resolution is not so likely. I do believe that, as the net customer, America does have reason to believe that it can get better trade terms than the ones that it has in practice at the time being.

Markets, though, will likely pingpong quite a bit as tensions continue to ebb and flow.

UBS's Weber's statement at Davos that normalizing rates is "mission aborted" is too stark. At least in the US, I believe that there has been a desire to normalize for quite some time. That said, the focus at the Fed to my view centers more on reducing the monetary base by allowing assets to bleed off rather than normalizing rates. In my view this is highly appropriate, though it will more than likely lead to higher levels of volatility than we've experienced over the last half-decade.

This criticism speaks to human nature: the Fed very likely does want to return to more of a market-driven monetary system, but without the messiness that move entails.

Due to the sheer magnitude of reserves, however, as well as the current and mostly healthy state of the market, the Fed is right to fret and not just hand over the reins to the animal passions of market behavior. The monetary policy is essentially trying to wind down a high-stakes experiment, and they need to get out without leaving a gigantic mess in the lab.

Term Structure

The VIX futures curve rests neatly, in no man's land as it were, between the modest HV10 and the more spasmodic HV20 (which, of course includes the HV10 data in its composition). The positive note on which Wednesday opened damped spot VIX to below 20.

My take is that we're not going to see spot vary much for the time being between 16 (a couple points above today's HV10) and 25 (a couple points below HV20).

Over the last year, there have been many instances where the F1-F2 traded neither in contango nor backwardation. This is another such occasion. Roll yield is modestly in favor of vol longs (VXXB, UVXY), but does not act as any kind of serious impediment to those who see further calming in the markets (SVXY).

Last week I mentioned the ultra-low VVIX (VIX of VIX futures) readings. Yesterday's drop in the S&P, which reached around 2% or so before wheeling back, caused a pop in this index. Rightfully so. Still, the overall levels speak to ongoing calm in the front end of the VX term structure. That's reasonable if one believes that the market is going to lurch around some, but ultimately succeed in mounting a recovery of sorts.


If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, I thank you for your ongoing contributions in the comments section.

I found this portion of a comment thread worthwhile to put out there for the broader readership. While I don't completely agree here (example Oct '14, Bullard "We could always do more QE"), I think that the basic premise is largely solid.

Jay Powell is actually noted for his consensus style leadership. Relative to more authoritarian personalities such as Greenspan, I think that more weight may be placed on the lower ranking members.

Thank you for reading.

Please Consider Following.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.