On Friday spot VIX closed at 17.31, the front futures month (March 2012) settled at 21.20, and the second month (April 2012) at 24.30. The difference between the second futures month and spot VIX is 6.99 – the second highest since VIX futures introduction in 2004. The highest was 7.02 the Friday before (17 February 2012). In the last several days there has been record steep VIX futures curve, especially on its short end.
VIX Futures Curve Chart
Let's start with the chart – VIX futures curve.
- The green curve is the latest close, Friday 24 February (spot VIX 17.31)
- The yellow curve is Wednesday 15 February, the highest spot VIX close in February (21.14)
- The blue curve is Friday 3 February, the lowest spot VIX close in the first half of February (17.10) and the last time when spot VIX was at about the same level as now
- The first mark on each curve is spot VIX, the others are individual futures contract months.
Historical Perspective
Since the introduction of VIX futures there have been 14 instances when the difference between the second nearest futures month and spot VIX was 5 or more VIX points.
A situation when the difference was above 5 for several days (as we have seen recently) is considered one occurrence, unless there were 11 or more consecutive trading days with the difference below 5. The date is always the very peak (the day when the difference was highest).
You can see more details in the table below.
- 0--2 = Second futures month less spot VIX (difference in VIX points)
- Days = Days left to second futures month expiration
- Final Sett = second futures month final settlement value
- Perf = Second futures month change from now to settlement
Note that in July 2004 (occurrence 2) there were 126 days left to expiration, because the VIX futures cycle was not purely mothly then as it is now. I have included this occurrence for completeness.
What It Means
Although the first VIX futures contango interpretation that comes to mind is that the market expects volatility to go up, you can see that in all but 2 occurrences VIX futures actually ended lower at expiration (and often even below the original spot VIX).
Does it mean that shorting 2-month-ahead VIX is a good idea under these circumstances? It might be, but...
- The sample is too small to draw any statistically significant conclusions.
- I have only looked at the difference now and at expiration – not what happens in between.
- Occurrence 7 is a big warning – when volatility increases, it sometimes increases big way.
After all, it would be a short volatility trade. The probability of profit is high, but so is the long tail risk. Maybe we can look at VIX options (April 2012) – but that's beyond the scope of this post.