Thursday, April 6, 2017

Low VIX Contango Thoughts

A few times over the last two weeks I noticed my trusty blade glowing blue, noting VIX had dipped into backwardation-
Tastytrade had a great discussion yesterday which pointed at some of the underlying macro VIX issues that you have to contemplate when having short VIX as a core position.  In summary, backwardation in VIX futures at such a low level has been almost unheard of and potentially reflects how much big money could be behind short VIX.  (Along with their trade idea of getting long VIX as without much contango you are getting long VIX without the roll cost which should be free money)

Is the small front month backwardation after the tiniest dip just a visual representation of buy the dip?  Conceptually the futures curve is pricing in a very short term vol contraction, which correlates with an equities rebound

 With this backwardation oddity I went off walking, rambling, thinking about futures curves in general.  Will the VIX curve always look the same?  As VIX products are traded more and more (and the equity options they are based on)  will these weird curve changes become more commonplace?

Would it make sense for a theoretical VIX futures curve to be a flat line at 15 or whatever the average is?  I keep coming back to the conviction that VIX futures have to keep in contango most of the time because there will always be uncertainty.  To lose the long term contango structure is saying  "the future is solved" and in finance terms there is no risk premium associated with thinking "some risk will occur in the future."

Will we see a much flatter front 2 months on the VIX curve when /VX is in the low teens?  I think this is definitely possible as more backtesting shows that periods of low VIX lead to more low VIX on average.

Going back to the actual trade ideas, the short term backwardation was a theoretical impetus to get long VIX with very little roll cost.  On paper that trade looks good but in the larger scope of assuming that the very backwardation implies a short term vol contraction, I think it is hoping for two opposite things at the same time.

Whether I end up wrong or right in the short term, the whole event was a time to contemplate conviction in your beliefs and process.  If I believe in the structure of VIX contango, then I have to be short VIX. (with risk management/ cash position)  Is this what religion or faith feels like? Is this the church of SVXY?

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