Back to the (VIX) Futures

Breaking News: The CBOE Market Volatility Index (VIX) is very low. I’ve heard that 5,000 times in the past couple of weeks. The market is very slow and non-volatile, it's late summer, and… Well, look -- it's certainly on the low end, but it's hard to justify really paying up for options here, so I can’t see it's so colossally out of line.

You know what’s not very low, though? VIX futures. August futures expire at the open today, so by the time you read this, they won’t exist. September VIX futures trade around 18.5, or a rather large $4 premium or so to VIX itself. November futures trade at 22.5, or an extremely large $8 premium to VIX itself. January 2013 VIX trades at 25.5, or a (insert impressive-sounding adjective) large $11 premium to VIX. January sounds like a while from now, but it's only about five months away, so that’s a pretty interesting bet on a future VIX rally.

Oh, and there’s this recent tweet from the CBOE:

$VIX futures open interest at a new high of 392,723 contracts on Monday - a 4th straight record day.

Clearly, the picture from the options world is more mixed than the VIX itself would lead us all to believe. The futures strongly suggest that the marketplace considers the current mid-teens levels to turn into a blip, followed by spiking volatility into fall and winter.

Before deciding what to read into it, consider that the steep slope of the futures curve (the term structure) is somewhat unprecedented. Remember the iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA:VXZ)? It's just like our friend iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX), but it tracks VIX futures with four-to-seven-month duration. It had stayed largely immune to the Contango issues that help destroy VXX over time, as the slope of the VIX curve out that far generally stayed flat. Not anymore; it's now at a record-steep slope, per Bill Luby.

So, it all comes down to what you believe about the VIX, and options sentiment in general. If you believe options reflect smart money, then the VIX futures curve should get you kind of bearish. I mean, prices are very high vs. VIX, and open interest is spiking.

If you believe options sentiment is a contra tell, then this will all seem very bullish. If they’re paying up for future protection, dollars to donuts (mmm, donuts) they are wasting money.

There are no absolutes, of course, only time will tell, but I tend to lean towards the former camp when dealing with individual stock options and the latter when dealing with index options. In other words, if someone’s loading up on puts and volatility is spiking in an individual name, particularly a smaller one, I’d tend to think it's smart money and wouldn’t want to fade it. If it's happening in an index, though, I believe the opposite -- it's nervous money that’s paying up for insurance they don’t need.