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VIX: Don't Sweat the Small Stuff


Minor variations are nothing to worry about relative to the big picture.

So what can we read into premiums/discounts in VIX futures? I ask because this came up in a comment the other day. The writer was noting some modest premiums in the VIX futures over the "cash" VIX. His point was that this was the market "predicting" higher volatility going forward.

I'd say the answer is that at best, this doesn't tell us much that we don't know. The VIX itself is mean-reverting. Most of the time (how did that mean-reversion supposition work out last October?). It's like a rubber band: If it stretches one way, it will likely recoil back. If you had nothing but the VIX, and it moved lower, you'd generally expect it to recapture that loss. I say "generally" because volatility assumptions aren't static. The VIX does move over the course of time. It's just that in the very short term, the market tends to expect volatility not to budge.

All the futures do is make that pre-existing mean-reversion assumption a little easier to spot. But before VIX futures, you could simply look at longer-dated SPX options. And you still can. Dollars to donuts when shorter-dated options moved in volatility terms, longer-dated ones probably moved the same direction, but not nearly the same magnitude. The longer the date, the less the move.

Another point I'd add is that the VIX itself isn't a perfect reflection of volatility assumptions at every given moment. Holidays, weekends, expected news, expected news that already happened, et al., can tweak it a bit. I'd suggest when you see a VIX at whatever level, assume anything 5% up or down could easily just be these little statistical quirks.

For example, let's say on Friday, SPY traders just assumed nothing would happen this weekend, and lowered bids on the July 95 calls to reflect that. They closed worth $2.90 on a 26.5 volatility. Now let's say Monday comes and indeed everything opens where it closed. And since these calls were already bid down, they open at $2.90.

There are 3 fewer days left, though, and they now carry a 27.5 volatility. If the VIX was based solely on this one series (and it's not remarkably far off, it's a 39 day ATM option on an SPX proxy) it would look like it rallied 1 point, or 4%. Yet nothing really happened. There's no higher level of fear now then there was at Friday's close.

My point is, these numbers are never perfectly right or wrong - they're estimates. And any analysis that makes a huge deal of relatively meaningless tweaks is doomed to uselessness. VIX futures are certainly valuable in that they won't move with every little VIX tweak. But don't get carried away with small variations in their relationship to the noisier VIX itself.
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