The Best of Times for VIX Futures Traders

For CBOE Volatility Index (VIX) futures traders -- the ones that go long: It's the best of times. Here's a comparison of the VIX term structure on Aug. 17, just before the market broke down, to the term structure on Friday, Aug. 28. In other words, here's what happens to futures when VIX doubles in a little under two weeks:

Kind of/sort of/kind of what you'd expect. Near-term futures ramped up 10 points, eight-month futures about 3.5, and everything else somewhere in between. I'm sure the guy holding futures in the middle there might wonder why he didn't get a bigger pop, but really, it makes some sense. Futures price in some degree of mean reversion in VIX. The pop was like lightning, so if nothing else, VIX will have to stay elevated a bit longer for the outer months to start believing it's going to last.

But alas, we know VIX rose faster than that. It peaked on both an intraday (53) and closing (40.74) basis on Aug. 24. So how about we add the term structure from that day to the graph:

If the term structure on Aug. 24 looks pretty identical to the term structure on Aug. 28, well, that's because it is virtually identical. Another way to look at it is that VIX dropped 14 points, about 35%, and VIX futures barely budged. The nearer-term futures dropped modestly, and the outer months actually lifted.

It's as good a reminder as any that VIX futures are NOT VIX. They price in mean reversion. Since the long-term mean of VIX is near 20, they tend to pivot around that level. If VIX is below 20, they "predict" a VIX rally. If VIX is above 20, they "predict" a VIX decline. They're right in the sense that VIX always revisits pretty much everything. But don't assume they're "smart" in any way, shape, or form.

That green line on the bottom has existed pretty much always over the last four to six years. And it's mostly wrong, as VIX mostly doesn't lift as much as futures price in or in as sustained a time frame. But occasionally they're "right." So is a broken clock, for that matter.

This go-around they were "right" in a big way -- perhaps the biggest way ever, when you consider that options on VIX futures had an unprecedented price explosion. And that blast paid for an awful lot of wrong calls on VIX. The players that endlessly rolled out worthless VIX call longs finally hit the lottery.

And I think that's the whole point of buying them, or any sort of VIX paper. It's insurance and it's cheap-dollar speculation on a volatility explosion. It's mostly not going to work, but on occasion it will, and on rare occasions, work incredibly well.

Right here, right now, it's a little odd that VIX futures didn't give anything back as the market lifted and VIX dipped. Smart money, though? We'll see, but I'd guess more along the lines of "trapped money" for anyone on the wrong side of this and trying to get back to whole again.