VIX Futures Backwardation

Discussion in 'General Discussion' started by Ryan Simmen, Apr 10, 2017.

  1. Ryan Simmen

    Ryan Simmen Well-Known Member

  2. DGH

    DGH Administrator

    Well, there is the ever-present fear of geopolitical crisis, but there is also the bubbling fear of rising rates which will impact financials. Note that XLF is also dropping. If XLF tanks then SPX can't be far behind.
     
  3. Paul Demers

    Paul Demers Well-Known Member

    Supposedly China just moved 150K troops to N Korean border today.
     
  4. Srini

    Srini Active Member

    Rising interest rates are helpful for banks since it improves "Net interest margin", hence the bank earnings. Bank earnings are more correlated to yield curve than level of interest rates. Flatter the yield curve, margins will be less.

    Snap2.jpg

    Regarding the VX futures and VIX, it is more of futures vs spot thing (maybe)
    Edit:
    French election first round is in April, but second round in May 7th. That is the reason for backwardation in that month. In fact if you look at Euro currency VIX, it is gone vertical in last 2 weeks
     
    Last edited: Apr 10, 2017
  5. Paul Demers

    Paul Demers Well-Known Member

    While that is true for the banks won't it cost all the other companies more to borrow money and adversely affect their earnings?
     
  6. Srini

    Srini Active Member

    Technically true. While rising interest rates helps bank, it hurts other industries. But level of interest rates is so low it is not material to the earnings in the beginning phase of the rising rates.
     
  7. AKJ

    AKJ Well-Known Member

    Understanding VIX, VIX futures, and variance swap calculations can be difficult, but hopefully I can help clarify a little:

    First, I'll offer my opinion for the current shape of the volatility term structure. I believe it is market angst over the French elections. You are free to disagree.

    1) April 21st expiry "VIX" - the screenshot shows a reading of 10.41. What is this? This is the fair price of a variance swap if it were struck today based on IV's of the April 21 2017 option chain. This is to say, if you used the VIX formula to calculate a pseudo-VIX that is forward looking for only 11 days, this is the measure you arrive at. Note that this is quite a bit lower than the actual VIX, and both the April and May expiry VIX futures. The reason is because the April 21 2017 options expire before the first round of the French elections, which occur on April 23. The options (and by extension the IV's) that are used to come up with this measure expire before the election, so the market is not incorporating the potential volatility related to the elections in pricing these options. Thus, this pseudo-VIX measure is relatively low compared to the same measure for slightly further out options.

    2) April 18th expiry VIX future - from your first screenshot, you see that this has a measure of 14.59. What is this? This is the market's expectation of the opening VIX print on the morning of April 19th. The way VIX futures are calibrated, it happens to be the day where the entire VIX measure is driven by the IV's of the May 19 2017 option chain. This futures contract is a way to bet on/predict what VIX will be on the morning of April 19th. Though this futures contract expires before the first round of the French elections, the options chain that is used to calculate VIX on this futures contract's expiration date falls AFTER the french elections. Therefore, market angst around the election is incorporated into the pricing of this future.

    3) May 16th expiry VIX futures - this futures contract is priced off of the June 16th 2017 expiry SPX option chain. The futures expires after the second round of the French election, as do the options from which the future is priced. So any immediate market volatility related to the election is not priced into the May VIX future or the June SPX options. This helps explain why the May VIX future is trading below the APril VIX future (local backwardation).
     
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  8. Ryan Simmen

    Ryan Simmen Well-Known Member

    This makes perfect sense. Thank you for the clarification!
     
    Last edited: Apr 11, 2017
  9. David Stewart

    David Stewart Well-Known Member

    I would take exception with one point AKJ made above about the market expectations for VIX on the morning of April 19th. Actually Brian Johnson says the exact same thing as well in his new book. I would point out that although you could think of it that way if you like, in reality there is always a risk premium added to the VIX futures as well, since anything can and will happen eventually. Market makers (and individual traders) are not going to sell those futures for what they may think the VRO will be on that day. They add a risk premium to compensate for the risk they are taking on. I know this is kind of a minor point but I still think it is somewhat important to understand. You can see this added risk premium all across the curve. The October futures are at 16.85 right now as we speak, that does NOT mean market participants think that VIX will be at that level at October expiration, rather it is a function of pricing those contracts with a reasonable level of safety to compensate taking on the risk of selling those contracts. That is the reason for the quote on quote "normal" curve that we normally see about 80% of the time. It really doesn't mean jack shit about where people think vol will be at that point in the future.
     
  10. Marcas

    Marcas Well-Known Member

    David, do you know how added premium you mentioned changes along vertical skew (away from ATM)?
     
  11. David Stewart

    David Stewart Well-Known Member

    Not sure what you mean, the VIX futures utilize OTM puts and calls around the ATM strike and extend outwards until there is a zero bid on the SPX options. But for sure the vertical skew affects the actual options on the VIX futures so the premium will vary quite a bit for example you can look at the implied volatility of the for example VIX put options and VIX call options and some options are a better "deal" than others at different times. I try to keep things simple and perhaps buy VIX puts out 7 to 10 days if the corresponding future has at least a dollar of premium over the cash VIX and pay as little as possible premium over parity for them. This might mean a couple of points ITM are better deals but of course they cost more money up front then ATM or OTM puts would. Then since the call side will have a positive skew all the time, you could consider a wide call spread to hedge the position. Although I frequently hedge the short vol side with some kind of SPX downward leaning structure myself. And remember that the delta of the vol products is inversely correlated to the vega of SPX. That's one of the reasons why a plain naked SPY or SPX put can hedge long puts in VIX or VXX. If the call side skew is steep a butterfly will be really cheap and can function as a hedge as well. I don't think that answered your question though. I'll think about it some more.
     
  12. Marcas

    Marcas Well-Known Member

    Thanks for explanation. I'm just entering this stuff so my terminology might be off.
    Generally I try to extract some info from term structure cuts not only thorough ATM but through OTM strikes as well (at this point, for clarity, I like cuts through pure IVs over VIX-like calculations). I just wonder how 'added risk premium' changes as we step away from spot. It's just curiosity. In other words if at atm we can assign, let's say 1point for this premium to expected IV in future, then how much 'risk points' will be added to futures 5% otm and how does it change with perceived marked risk.

    Hmm, if it is too confusing just forget it. I will show you what I mean on graph when I'm ready : )
     
  13. Nam

    Nam Member

    Good discussion. Most people don't realize that VIX future is expectation value of FORWARD volatility and not spot VIX. For example:

    April VIX future= E_Q(forward(8D,38D))
    =forward(8D,38D)+basis

    where forward(8D,38D) is the spot volatility from Apr19 tp May19, viewed from today, a concept similar to forward interest rate. This is what AKJ referred to in his #2, and basis is what D Steward referred to as risk premium

    This kind of divergence happens not infrequently. Last time it occurred was at the end of Feb. I wrote about it here, along with a formula for forward vol:

    http://blog.harbourfronts.com/2017/02/28/forward-volatility-and-vix-futures/
     
  14. David Stewart

    David Stewart Well-Known Member

    nice blog Nam, I'll check it out, going to sleep now though ;)
     
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  15. Srini

    Srini Active Member

    Interesting chart in Daily Shot today.
    Snap3.jpg
     
  16. onyxperidot

    onyxperidot Well-Known Member

  17. Srini

    Srini Active Member

    Agree with his final sentence. "No stability without volatility". Even though Talib generally attrbutes low volatility to never ending government (Fed) put, there should be some blame to rise of myriad of volatility etf's. Now every mom and pop is in the game of shorting vol's.
     
  18. onyxperidot

    onyxperidot Well-Known Member

  19. David Stewart

    David Stewart Well-Known Member

    Thanks for sharing Srini, hadn't seen that article yet
     
  20. David Stewart

    David Stewart Well-Known Member

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