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Monday, April 15, 2024

VIX Futures Contango Bubble

VIX Futures Contango Bubble

Courtesy of Bill Luby at VIX and More 

Truth be told, there is no such thing as a “contango bubble,” but I like how the two words look juxtaposed and it is Friday…

KEREM BEN ZIMRA, ISRAEL - OCTOBER 07:  Merlot grapes hang heavy on the vine during the harvest for the Dalton winery on October 7, 2009 in Kerem Ben Zimra, northern Galilee, in Israel. Dalton is one of scores of kosher wineries that are at the height of the harvest season. More than 130 Israeli wineries, many of them small boutique operations, produce an estimated 35 million bottles of wine a year, most of it kosher according to Jewish law.  (Photo by David Silverman/Getty Images)

Bubble or not, the VIX futures are stretched to an extreme that I do not ever recall seeing and to the extent that the grapevine is whispering to Adam Warner of the Daily Options Report that the differential between the first month and third month VIX futures is at its highest level ever. (Note to self, why doesn’t the grapevine ever whisper to me?)

The chart below, courtesy of FutureSource.com, shows the difference between the VIX third month futures and front month futures (VX V0 – VX N0 in current VIX futures parlance) going back about six months. Personally, I tend to get excited when the third month VIX futures rises more than 2.00 higher than the front month, as this frequently suggests that the VXX negative roll yield contango play is starting to set up.

Some 17 months after its launch, I probably still get more questions about VXX than any other subject. As much confusion as there is about VXX, I think it is probably time to come out with an extended look at this volatility product in the next week or two.

For more on related subjects, readers are encouraged to check out:

[source: FutureSource.com] 

Disclosure(s): short VXX at time of writing

Comment by Ben:  I don’t understand what this means. Is it a signal to short VXX? Buy it? Or VXZ? Or what?

Bill’s response: It is not a signal to short VXX, though that is the position I currently have on right now. What it means is that the consensus is that the VIX has fallen too far, too fast. The VIX futures indicate that the market believes the VIX will spike back up into the 30s over the course of the next few months. My thinking is that it is more likely that the VIX futures will come down toward the current VIX level than the VIX spike back up to the level of the futures. Eventually the VIX and VIX futures converge at expiration. The question is which one moves the most in order to make that happen.

The other important point (spelled out in the links) is that because of the contango in VIX futures, VXX will continue to lose value every day (like a leaky balloon), so VXX buy and hold positions will have to deal with a significant negative roll yield while they are waiting for the VIX to spike. I see the negative roll yield as comparable to time decay on short options positions or a daily dividend of sorts for shorts. Obviously, my opinion is in sharp contrast to the market consensus.

I hope this helps.

– Bill

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