Using the VIX Futures Term Structure to Predict Volatility ETP Prices

Status quo forecasting is sometimes very easy to do.  For example, if you predict that tomorrow’s high temperature will be the same as today’s high, your estimate will be close to the actual high much of the time.  Predicting volatility Exchange Traded Products (ETP) prices is not so straightforward.

The VIX futures that volatility ETPs like VXX, SVXY, UVXY, and TVIX track are similar to stock options in that they have a time value that usually decaying.  Generally the longer the VIX future has until expiration the higher its price.  If you plot VIX futures prices versus time until expiration the chart often looks like the one below from VIX Central.  This curve is called the VIX Futures Term Structure.

The term structure curve can be relatively stable for significant periods of time—which raises the question of whether we can use the term structure to predict volatility ETP prices.

Even if the price vs time curve of the VIX Futures stays exactly the same, several underlying factors that impact the prices of the volatility ETPs are in a state of change.  For example:

  • The individual VIX future’s prices change as they approach expiration
  • The mix of VIX futures that determines the ETP values changes based on their time to expiration and their prices
  • The position size of VIX Futures held by the leveraged ETPs (e.g., TVIX, UVXY, SVXY, VMIN, ZIV) changes on a daily basis based on the previous day’s percentage moves

Assuming the VIX futures term structure is stable (including the Cboe’s VIX spot price) allows us to project how much decay/gain is “built-in” to the prices of the long/inverse volatility ETPs. This information can help us set strike prices for option strategies, set limit prices, and determine risk/reward parameters.  More than 80% of the time, the VIX Future Term Structure is in a configuration called contango, where futures with more time until expiration are priced higher than the “spot” VIX price.  While in contango, decay factors on long volatility funds like VXX, UVXY, and TVIX can be considerable as can the boost factors on inverse funds like SVXY, VMIN, and ZIV.

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Near Real Time Graphical VIX Term Structure

Anyone that follows volatility closely knows that short term views on volatility are much more dynamic than longer term. For example, if the market is moving from a dip into a “V” style recovery the CBOE’s 9 day expectation of volatility VXST, will drop much more than the 30 day VIX. A chart showing volatility expectations vs time is called a volatility term structure.  The …

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The Volatility Term Structure is Driven by OTM Puts

The CBOE’s VIX® methodology calculates a single theoretically grounded number that quantifies virtually the entire volatility landscape for a specific point in time—pretty cool.  Prices for hundreds of different options with different expiration dates can be involved in the calculation.   This single number is very useful, but obviously, lots of information is discarded in the distillation.  I’ve wondered if the VIX’s compression is hiding some information …

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A 3D View of the S&P 500: Price, Time, and Markets

There are lots of valid ways to look at the market.  Obviously, price is important, but a number alone (e.g., 1487.85—the Feb 25, 2013, S&P 500 close) doesn’t mean much.  Price related metrics like percentage changes and support/resistance levels add value, but adding time as a factor enables some really interesting measures like moving averages and momentum trackers.    My favorite time-related metric is term structure—how the …

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VIX Term Structure

Anyone that follows volatility closely knows that short term views on volatility are much more dynamic than longer term. For example, if the market is moving from a dip into a “V” style recovery the CBOE’s 9 day expectation of volatility VXST, will drop much more than the 30 day VIX. A chart showing volatility expectations vs time is called a volatility term structure.  The …

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