What’s the inverse of a rising tide lifting all boats? Maybe the sinking VIX drowning a whole fleet of trading products.
It has been well publicized that the VIX is back to levels not seen since April, ahead of the flash crash. And I’ve gone on and on about the problems with the iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX), which fails miserably at tracking VIX moves. But until now, longer-dated VIX futures have been fairly immune to declines in the VIX. Premiums stayed strong as everyone half expected another market shakeup at some unspecified time in the future.
Perhaps 2008 has now receded enough down the memory hole that investors/traders see less of a need to pay up for longer-term insurance. Here’s a snapshot of how VIX futures opened on Monday:
The VIX printed about 19.25 at the time. There’s still premium left in the futures beyond November, but it’s much lower than we saw this summer. December has about 6.5 weeks to expiration and carries a roughly $2 premium. It wasn’t that long ago we saw $6 premiums in similar duration futures.
At the other end, we see June carrying $7 versus $10 and above for similar duration futures not all that long ago. Not to mention the absolute values of out-month futures were in the low 30s, so it’s a double whammy for futures owners in that they got hit by declines in the VIX itself and by the futures premium erosion.
This has taken a huge toll on the iPath S&P 500 VIX Mid-Term Futures ETN (NYSE: VXZ), which proxies VIX futures with a four-to-seven-month duration. Here’s how VXZ looks over the past six months:
That’s a 27% drop since late August in what was previously a pretty placid instrument. VXZ does not have the same structural challenges of VXX, namely the contango drag. The VIX futures curve is virtually as flat as the world in a Thomas Friedman book, so there’s little cost rolling out to maintain duration. That VXZ decline simply reflects declining fears about volatility out in time.
Going forward, you can argue both sides. VXZ obviously represents a better buy now than it did three months ago if for no other reason than you are buying a lower VIX with lower VIX futures premiums. On the other hand, the VIX is not cheap compared to realized volatility of the S&P 500 (SPX), which currently resides near 11. So if you pay 26 for an out-month future, you are anticipating that realized volatility in the market will double by then.
Follow Adam Warner on Twitter @agwarner.