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VIX Futures Come in Like a Bear


Watch this cycle; large premium to realized volatility is predictive.

Well, despite a rather slow session yesterday, we've had some very interesting developments in volatility land.

This, from Jason Goepfert: "Options expert, and unofficial (though enthusiastic) VIX bikini spokesman Adam Warner noted today on Twitter that we may be in for an uptick in volatility based on where the VIX index is relative to historical volatility and also to VIX futures."

To clarify, I'm not Sy Sperling with this VIX-wear (I don't own the company, nor am I a customer). I am, however, a staunch advocate.

And oh yeah, the options stuff. As ugly as we see the VIX, it remains at a rather large premium over realized volatility in SPX. Again, McMillan notes that the premium averages about 4 points. We're closer to 10 now. Keep in mind that excess premium is predictive of increased SPX volatility; it's not predictive of a directional move in SPX.

But wait, there's more from Jason.

"The futures traded at an exceptionally wide discount in the craziness last fall, and are now at the opposite end of the spectrum. Since April, the spread between the 2 has traded in a pretty well-defined channel, and we can see from the little red (or green) arrows that when the VIX spread hit its upper (or lower) trendlines, then the S&P tended to decline (or rally)."

Click to enlarge

August is probably the key cycle to watch about this far out, and it's now a 4.50 point premium to "cash" VIX. And remember that cash VIX is itself at a large premium to realized volatility. So throw it all together, and August VIX futures are at a very large premium to realized volatility. And that's predictive (bearish) as per McMillan, although in a very small sample size (only 5 instances).

Personally, I'm not a huge fan of, nor am I reading much into, VIX premiums and discounts. There are occasional quirks that may cause the cash VIX readings to mistate real volatility. Things such as holidays and expected news events will do that. (Think of stock pre-earnings, implied volatility will pump before earnings and tank after.) But that being said, this isn't one of those times, There's no holiday, and there's no particular news event on the docket.

Now it could just be telling us that summer will remain very slow, but volatility will return to life in September. Remember a VIX future is a snapshot of where the VIX will be on expiration day, not a measure of volatility between now and expiration day.

But whatever the explanation, all we can do is look at the numbers, and these relationships all stand out and don't bode well.
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