What VIX Futures Really Tell Us

Clarifying the relationship between the CBOE Volatility Index (VIX), realized volatility, and VIX futures

by Adam Warner

Published on Jan 12, 2016 at 9:40 AM

They talk a lot about volatility on TV. I joke about it (often) as in "everybody expects higher volatility going forward … always," but I do understand the genesis behind the fixation. Volatility = ratings. The more volatile we get, the more likely we are to tune in to financial TV, read financial websites, log in to our accounts, trade, invest, cry, etc.

It's good for business in every which way. So it pays to sell "volatility" (the concept, not actual options). And when there's no actual volatility, sell the perception of volatility.

Again, I get it. The Weather Channel gets much better ratings when there's a blizzard or a hurricane on tap, CNN does better when there's a big news story, etc.

And hey, it benefits me, since I write about volatility. I don't trade much these days, but it helps that business, too. Volatility is basically the pool of available profits. The more volatile, the more profit opportunity. It doesn't help my investment portfolio in that volatility is generally associated with a downward trajectory in prices, and I'm not exactly loaded up on iPath S&P 500 VIX Short-Term Futures ETN (VXX). So, yay volatility from a media perspective! Keep talking it up, financial bobbleheads!

Just one request: At least talk about it accurately and coherently. For example, the other day, I heard a reporter note that the CBOE Volatility Index (VIX) was higher than VIX futures, which is true right now. He took it to mean that "traders" were anticipating higher short-term volatility. Um, no.

VIX itself is a proxy for volatility assumptions going forward. Specifically, it's an estimate of the realized volatility (RV) of the underlying -- the S&P 500 Index (SPX) -- for the next 30 calendar days. If VIX is higher than some measure of backward-looking realized volatility, then it's accurate to say that VIX is pricing in an increase in volatility going forward. And right here, right now, that's the case. Ten-day RV is about 15, VIX is 27, so it's pricing in a substantial increase in volatility.

Now, it's important to note that the 15 RV is a bit misleading. It includes the non-volatile days between Christmas and New Year's. We've obviously seen an uptick in vol since then. VIX at 27 prices in a range of roughly 1.6% or less on two-thirds of days. That's reasonable with what we saw last week. Even amid all the ugliness, there were two low-range days without gaps.

So let me reconcile the TV statement with something more accurate. VIX is at a modestly higher-than-average absolute level. It suggests that the marketplace anticipates that current realized volatility levels will persist over the next month. By "current," I mean levels of the last week or so.

What's more, the CBOE 3-Month Volatility Index (VXV) proxies volatility over the next 90 days. And it's about the same as VIX now. So the marketplace actually anticipates current realized vol will persist for 90 days.

VIX futures? They're a much different animal. Basically, ignore anyone using them as some great volatility anticipation tool. All they do is give you a "snapshot" of VIX on some future date.

But remember, VIX itself looks forward 30 days. So all a future "tells" us is where that market expects future volatility to be on some later date. They provide trading and hedging functions, of course, they just don't lend themselves to analysis via the quick soundbites of television.

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


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