VIX Futures Contango

first posted: 2021-06-16 15:01:24.387590

Here is what the vix future curve looks like for the 3 previous close:

Whats is the Future Contango

A VIX future contract is worth the spot vix index at maturity. The spot vix represents 30 days index volatility,. It traded historically in a range of 9 to 80. Each month future contract correspond to a volatility quote from contract expiration to the next month contract.

The contracts cover disjoint volatility periods, their value corresponds to the expectation of volatility over disjoint periods. In theory, locking the volatility of a portfolio for the coming year would require to buy a stream of VIX options, not just a single one.

Volatility has a tendency to autoregression, which means that some covariation is expected due to the fact that spot volatility and long term averages are the best estimates of future volatility.

When the spot VIX is at historical low level, vix future have a contango (upward future curve), as new information could arrive at any moment that could increase the volatility. When the spot VIX at historically elevated levels, the market anticipates a mean-reversion of the volatility, which causes futures backwardation (downward sloping curve).

VIX Contango and Portfolio Insurance

While downmarkets are strongly associated to higher volatility, VIX is not strictly speaking volatility insurance. It is possible to lose money on an equity portfolio while the volatility remains at 20%. The cost of insurance corresponds to the theta of options, and this occurs even when volatility is constant.

The VIX index is a parameter driving the cost of portfolio insurance. The VIX future contango shows the expected evolution of this parameter.

It can be explained by the possibility that news could occur suddenly that make the next future VIX much higher than the spot VIX fixing of the day. Such unforeseen news can be modeled as having a constant (Poisson process) rate of arrival in the future, in which case, the VIX futures increase linearly.

The fact that contango does not increase at a linear rate, but tends to flatten for longer maturities implies expectations that any shock is usually transitory and do not last more than a quarter.

VIX Quotes for various expiries

Here is the aspect of VIX quotes over more recent times:

VIX Long Dated Contracts are Less Volatility

Here is the vix series for current month, month 2 and 8th rolling:

Spread tends to be positive when volatility is low.

Here is the spread:

The most dangerous tradeis to short the short-dated future to try capture the rapid convergence to spot in the last month. Going long a longer maturity vix future is never a good hedge as the spread shows.

The reverse trade benefit in case of tail risk event, there are special case where the curve is linear or convex, and where gets tail risk protection for free.