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Futures Show Muggy July for VIX

Volume dries up and VXX could implode again


A strategy idea for options trading investors.

So we get a four-day rally in the markets, and wouldn’t you know it, yet another implosion in the iPath S&P 500 VIX Term Futures (NYSE: VXX). The SPDR S&P 500 (NYSE: SPY) lifted about 2.5% while VXX has pared about 12%. Volatility as an asset class works … pretty poorly.

But hey, its actually not a horrible setup for VXX, at least from a CBOE Volatility Index (CBOE: VIX) tracker standpoint. VIX closed at 18.86 yesterday. July VIX futures closed at a $1 premium, not terribly high. And the August futures closed .85 over July. That’s all pretty flat in VIX Term Structure land. And that’s a relatively good thing for VXX, which as you might remember, has to roll from the first cycle out to the second cycle to maintain a constant 30-day duration. Yes, VXX loses small each day, but that premium often exceeds $2.00, so by contango standards, its not terrible. What’s more, VIX itself is kind of middle ground in the high teens.

There is one big fly in the ointment though. If the market hangs in a couple more days, VIX is going to get very heavy, very quickly. The July cycle is the worst cycle of the year for VIX. At least that’s what I found running numbers for my book. Summer dries up volume to begin with, and having a long holiday weekend smack dab in the middle of the expiration cycle mutes any desire to pay up for options. Obviously an *event* trumps any of this, but the pressure really reside with the option buyers.

So what I’m saying is that the relatively flat and docile VIX term structure can get steep before you know it. And that will happen via a drop in VIX itself, followed by weakness in July futures.

I’m small long the VelocityShares Daily Inverse VIX Short-Term (NYSE: XIV), and would buy more into any VXX strength over the next couple days, so that’s my (very short-term) opinion.

Follow Adam Warner on Twitter @agwarner.

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