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Analyzing the CBOE Volatility Index (VIX) futures term structure
Time to get Back to the Futures! As we periodically note, CBOE Volatility Index (VIX) futures always anticipate a future VIX lift, provided VIX itself hasn't already lifted too much. On Oct. 15, the term structure looked like this (click chart to enlarge):
VIX itself closed over 30, so the whole complex was under water -- and rightly so. Remember that futures basically snapshot where the market expects to see VIX on the day they expire. You can't arb by "selling" VIX -- really a proxy via S&P 500 Index (SPX) options -- and buying a VIX future at a discount. They are two different animals.
So, at the height of the VIX boom, the market anticipated VIX would settle in around the low 20s. That turned into quite the poor bet on the long side, no matter what the expiration. But, now that the recent storm has passed, the VIX term structure has returned to its regularly scheduled programming (click chart to enlarge):
Well, regularly scheduled, but with some hangover effects. Here's how we look now compared to how we looked on Feb. 24. The VIX was around the same levels in February, and we were also a few weeks out from a volatility uptick (click chart to enlarge):
Comparable futures are a point or so higher now than they were in February. And, that probably understates the volatility bullishness, as we're heading into a seasonally slow time of year for volatility.
As we noted yesterday, volatility trading boomed in October. So, combine that with the price action, and it's not a leap to suggest that overall bets on volatility have increased. It's bullish for the markets on the margins, if you view it all through a contrarian lens. But, I wouldn't go crazy reading too much into this. Again, VIX futures predict many more VIX pops than we actually see. And, they guess right about as often as ESPN's Monday Night Countdown crew does. But, the fact that VIX always tells us the same story mitigates its usefulness as a contrary indicator.
The big lesson here, in my humble opinion, is one I've heard options experts preach since Day One: When volatility pops, sell time. Nearer-month options are more tempting thanks to their increased implied volatility price tag. But, you're actually better off owning these and using the long gamma to flip into the elevated realized volatility, and then selling longer-term options and capitalizing on the eventual volatility drop.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.