Schaeffer's Trading Floor Blog

Finding the Smart Money in VIX Futures

How you could've timed the CBOE Volatility Index (VIX) just right -- and still botched a trade

by 8/14/2014 8:03 AM
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We haven't looked at CBOE Volatility Index (VIX) futures much lately -- maybe thanks to the fact that VIX itself has moved around a bit more than normal. But alas, all good things must come to an end. We're back with a 13 full, which is pretty much the new normal, or at least the normal of this low-volatility regime we sit in.

So, how about we take a gander at what "seers" expect to see in VIX down the road.

VIX Futures Term Structure

Well, if it seems like the term structure never changes, that's because it truly never changes. We just had a little blip up in volatility, but it didn't alter expectations all that much.

It's pretty safe to assume every random six-month period will see some sort of VIX pop. A VIX futures buyer needs a more permanent lift to truly benefit. Or he needs very prescient timing but you can say that about any play.

Almost exactly six months ago, VIX itself sat in the high 13s after a more impressive pop than the one we just saw. How did the term structure look then?

VIX Futures Historical Prices - Feb 2014 vs Today

That's pretty impressive. There was slightly more "optimism" in the middle part of the curve; otherwise, they're essentially identical. And of course, buyers of VIX paper of three-to-four months' duration in February did pretty poorly. VIX itself mostly drifted, before bottoming near 10 on July 3.

As luck would have it, VIX was in the mid 13s almost exactly a year ago, although this time it was in the middle of a modest rally. So, let's overlay that term structure next.

VIX Futures Historical Prices - Feb 2014, Today, Aug 2013

We were so young and innocent back then, apparently. VIX was surely grinding its way back to 20 by March/April 2014.

Except it didn't. VIX averaged about 14 in that stretch. So much for those crystal balls! It did pop over 20 in February, though. So, if you owned March or April futures and held on, you had an out, right?

Well, wrong again.

Here's how the term structure looked on Feb. 3, which hindsight tells us was the peak in "spot" VIX.

VIX Futures Historical Prices Feb 2014

Those futures were about 18.5. So, you could have come reasonably close to timing a VIX pop, and STILL done quite poorly.

Who's the smart money? Whoever sold the longer-dated VIX futures in early February at a decent discount to cash. Those 210- and 240-day VIX futures are September and October paper, and as you can see from the first chart up above, they're in the 15 range now.

The larger point in all this is that the next time you hear about surging VIX futures or call volume, take it with a grain of salt. It's quite possibly on the wrong side of the market, but most likely, it's just guessing an outcome that will bear about zero correlation to the ultimate reality.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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