Schaeffer's Trading Floor Blog

Fun With Volatility Graphs

Learning from past VIX trends

by 2/4/2013 7:26 AM
Stocks quoted in this article:

Okay, I took a few minutes off from analyzing Beyonce-related prop bets to play around with this new VIX Central site. I wanted to look at VIX term structures at some random times to see if the VIX futures curve looks the same over and over again.

For example, here's the vantage point from the 1st day of February on the last four years, including this year. (Click the charts below to enlarge.)

VIX Term Structures Chart for Feb. 1
Chart courtesy of VIX Central

It's generally similar, but not quite identical. The slope on this day last February was considerably steeper, which possibly means the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX) isn't horrendous now on a contango basis. It probably just suggests that the VXX was spectacularly bad this time last year. The iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA:VXZ) too, for that matter, as the four-to-seven month part of the curve looks unusually steep as well.

It wasn't always this way, though. Here's Feb. 2, 2009:

VIX Term Structures Chart, 2009
Chart courtesy of VIX Central

It was a slightly different world back then. The ugliness of the 2008 market was about six weeks from ending. The CBOE Market Volatility Index (VIX) itself was still hugely elevated. And the market (rightly) presumed it would not last.

Just for fun, let's say on Feb. 2, 2009, we sold one future at every expiration. And then did nothing and just let it cash settle on the day it expired. Care to hazard a guess which cycle turned into the best sale? I'll even give a tip: The VIX peaked in early March.

Okay ... here's the graph of the actual VIX for 2009.

Chart of VIX for 2009
Chart courtesy of TD Ameritrade

It's tough to tell for sure, but it looks like the furthest and cheapest cycle, November, was ultimately the best sale. The November futures were about 36 in February, and they ultimately settled near 22.

Does that sound counterintuitive? The cheapest volatility on the board ends up being the best sale? Yes, it's counterintuitive, but it's also generally the right course of action. The smartest guys in the volatility room used to swear by selling calendar spreads into volatility spikes, even if the calendar involved buying near-term volatility way higher than the longer-term volatility being sold. That's because the near-term volatility spike is often justified by the spiked volatility in the underlying instrument itself, whereas the longer-term volatility is simply overpriced.

Right now, we almost have the converse situation. Near-term volatility is the cheapest on the board, yet it is considerably higher than the realized volatility in the market itself. The 10-day realized volatility in the S&P 500 Index (SPX) has spiked recently all the way from 4.5 to 7. The VIX, at 13, remains modestly "high" in comparison. If you want to sell options, you're better off taking your chances in the nearest two cycles than going out in time and locking in higher volatility.

Disclaimer: The views represented on this blog are those of the individual author's only, and do not necessarily represent the views of Schaeffer's Investment Research.

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