What is the relation between the VIX index and VIX futures? + Recap of July's Trade
What is the relation between the VIX index and VIX futures? + Recap of July's Trade
Level 1 - Zero to Options Hero
In our recent posts we have gone over the history and origin of the VIX index (here), as well as some time-sensitive trade ideas on positioning for a rebound in the VIX as the summer lull in volatility recedes (here and here). In fact, the spot VIX index has gone up from 15% at the time of publishing the trade idea to 18.5% now, a 23% move or 3.5 vol points in traders’ parlance. Sounds like a pretty profitable trade, huh?!
Well hold on, let’s look into:
what is the VIX futures curve,
the shape of the curve on July 7th when we recommended the trade,
whether simply buying a 3-month VIX future at trade inception would have been profitable,
whether the futures curve trade has been profitable so far.
What are VIX futures?
VIX futures are like any other listed financial futures contract, in that they are traded on an exchange with daily margin requirements, and allow speculators and hedgers to have exposure to the VIX index on that future date (known as the settlement date). The most actively traded futures contracts are the quarterly contracts that settle/expire in March, June, September, and December (and have codes H, M, U, Z). Since these are financial contracts (not physical commodities futures contracts), they simply represent the traders in the market’s expectation of where the VIX index (otherwise known as spot VIX) will be on the settlement date.
What was the shape of the VIX futures curve when we recommended the trade?
By plotting the prices of the futures contracts (price on the y-axis, settlement date on the x-axis), and then drawing a smooth line through the points, we can see the market’s pricing of the VIX futures curve. If we recall the chart in the previous post, the VIX futures curve was upward-sloping in July, which is usually the case when spot VIX is abnormally low as volatility is a mean-reverting process1.
Would simply buying a 3-month VIX future at trade inception (July 7th) have been profitable?
Although October 7th (3 months out from trade inception) is not an actively traded futures settlement date, the Chicago Board Options Exchange helpfully publishes the interpolated (remember that smooth line..) VIX for standard tenors i.e. 9-day, 3-month, 6-month, and 1-year on each trading day, which can be pulled up in my favorite graphing tool, TradingView.
On July 7th, the VIX3M was ~17.25 vol, while spot VIX today (about 3 months later) is 18.6 vol:
Also, interestingly the implied correlation that we mentioned in our inaugural post
has picked up (gone higher) from 20% to 27.7% (using another handy ticker on TradingView, COR3M).
So yes, buying a 3-month VIX future at trade inception would have been profitable, to the tune of 1.35 vols.
Would the futures curve trade that we recommended have been profitable so far?
We recommended buying 2x the 5-month future versus selling 1x the 3-month future, so let’s see if this trade would have done better than simply buying the 3-month VIX future!
As described above, being long (a.k.a. buying) the 3-month future would have resulted in a 1.35 vol profit. So selling 1x the 3-month future would have resulted in a 1.35 vol loss. What about the P/L on buying 2x the 5-month future (which would have 2 months to settlement today)?
Unfortunately, the CBOE does not post a VIX2M or VIX5M, so let’s use VIX3M and VIX6M and do a little bit of arithmetic to approximate the answer!
On July 7th, VIX3M was 17.25, and VIX6M was 19.3. Using a linear interpolation, VIX5M should be:
To find the P/L we need to find VIX2M today. Again from TradingView/CBOE we know that spot VIX is 18.6 and VIX3M is 19.5. Using the same linear interpolation technique, VIX2M should be:
Therefore, we would have made 19.2-18.6 = 0.6 vols, which on 2x the position would mean we made 1.2 vols on the long 5-month future, but lost 1.25 vols on the short 3-month future. So in fact the total P/L on the position is -0.05 vols.
Why did this trade not work out as expected? In fact, the VIX futures curve is higher but also flattened out. This means that traders expect this current rise in volatility to be fairly well contained, or that the mean reverting nature of volatility will start kicking in soon.
We hope this article was enlightening as both an intro to the VIX futures curve and an analysis of how the previous trade recommendation went. Happy to answer any questions, and until next time!
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Don’t worry if this is confusing, we will write another post about this in the future!