Friday, May 18, 2007

VIX Futures: The One Picture to Remember

There are really only a handful of important things to remember about the VIX. I can summarize the most important ones as follows:

  • The VIX is generally negatively correlated with the SPX
  • The VIX is a mean-reverting animal
  • VIX options prices are calculated off of VIX futures

Now raise your hand if you follow the futures market. I thought so. Well, neither do I for the most part, but I’m quickly coming around to futures as a useful tool for getting a better handle on how investors are thinking about and betting on the future.

Rather than try to sound like some sort of evangelist, however, let me just offer one chart, which comes courtesy of the CFE. I will skip the commentary, other than to translate the obvious into some numbers: when the VIX jumped 64% from February 26th to February 27th, the nearest futures, the March ’07 VIX, moved less than half as much in percentage terms. Looking further out, the August ’07 VIX futures moved about one tenth of the VIX index, while the November ’07 VIX futures moved about one thirtieth as much as the VIX did.


Bill Luby said...

A reader asked that I provide some commentary for this chart, so with the necessary preface that "I am not a futures guy" -- and don't even pretend to be one on the internet (yet)...

* On the day of the biggest rise in the VIX in history, the consensus opinion of where the VIX would be 9 months out (Nov 07) was essentially unchanged -- and if you had Nov 07 calls, heard that the VIX went up 64% and rushed to get a quote on your position, you probably would have been more than a little disappointed
* The difference between the 2/27 spot/cash VIX and the Mar 07 futures indicates that the consensus was expecting the VIX to fall at least 20% in the three weeks or so remaining during the contract
* The two extremes of opinion (low volatility environment on 2/26 and high volatility environment on 2/27) were still guesstimating a fairly similar future, with a VIX of 14ish for May 07 and 15 (or a little under) by Nov 07
* Most of the VIX futures price action is, not surprisingly, in the front month
* Calendar spreads present some interesting possibilities
* The futures have been a good estimate of future VIX index prices, at least so far
* In the event that it was not obvious prior to seeing this graphic, it should be obvious now that anyone who is considering trading VIX options cannot use VIX index pricing data to establish trading strategies. Instead, one needs to look at the action of the options themselves, perhaps considered in the context of the VIX, SPX, etc.
* Many newbies who rushed in to buy VIX calls after 2/27 probably were not aware of the expectations being priced in by the futures -- and probably paid a lot more than they thought they did

That's it for now.

Anyone else care to add some takeaways?

Anonymous said...

now I stay in touch..

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