The VIX Futures Basis: Evidence and Trading Strategies Volatility has become a widely accepted asset class since the introduction of the VIX futures contract in realm of trading strategies involving buying and selling “volatility.” Namely, that there exists a condition whereby the popularity of selling “vol” has evolved to a .
Academic research states that volatility follows a mean reverting process, which implies that the basis reflects the risk-neutral expected path of volatility. When the VIX futures curve is upward sloped in contango , the VIX is expected to rise because it is low relative to long-run levels, as reflected by higher VIX futures prices.
Likewise, when the VIX futures curve is inverted in backwardation , the VIX is expected to fall because it is above its long-run levels, as reflected by lower VIX futures prices. The investor sells buys the nearest VIX futures with at least 10 trading days to maturity when it is in contango backwardation with adaily roll greater than 0. The daily roll is defined as the difference between the front VIX futures price and the VIX, divided by the number of business days until the VIX futures contract settles, and measures potential profits assuming that the basis declines linearly until settlement.
Evidence and Trading Strategies http: This study demonstrates that the VIX futures basis does not have significant forecast power for the change in the VIX spot index from through but does have forecast power for subsequent VIX futures returns. The results indicate that these trading strategies are highly profitable and robust to transaction costs, out of sample hedge ratio forecasts and risk management rules.
Overall, the analysis supports the view that the VIX futures basis does not accurately reflect the mean-reverting properties of the VIX spot index but rather reflects a risk premium that can be harvested.
The Expected Return of Fear http: Even though there is substantial risk that the VIX rises further during these turbulent market periods, however, subsequent average futures returns are close to zero or even positive, rather than more negative. This phenomenon is predictable using real-time data on the slope of the VIX futures curve. Movements in price risk exposures and positions suggest that low demand for insurance from long investors drives this effect.
A short futures investor who earns substantial returns during calm periods but otherwise pays out during VIX spikes can significantly reduce risk by moving into cash when the futures curve slopes downward with little detectable cost to expected returns, earning a 3. The shape of the VIX term structure conveys information about variance risk premia rather than expected changes in the VIX, a rejection of the expectations hypothesis.
Slope's predictability is incremental to other proxies for the conditional variance risk premia, is economically significant, and can only partially be explained by observable risk measures.
Volatility Derivatives in Practice: Activity and Impact http: We use unique regulatory data to examine open positions and activity in both listed and OTC volatility derivatives. Gross vega notional outstanding for index variance swaps is over USD 2 billion, with dealers short vega in order to supply the long vega demand of asset managers. To the extent that dealers take on risk when facilitating trades, we estimate that the long volatility bias of asset managers puts upward pressure on VIX futures prices.
Hedge funds have offset this potential impact by actively taking a net short position in nearby contracts. I developed in a previous working paper the Sidre and Most-Strategy. The strategy relies on the typical termstructure of VIX futures. The Calvados is a refined and condensed version of these strategies. Convergence-divergence relationships between these instruments generates series of expectations that assist in trade planning and risk management.
Also pay attention to interactions between the indicator and the 50 and day EMAs , with those levels acting as support or resistance. For related reading, see: Momentum Trading With Discipline. VIX settles into slow-moving but predictable trend action in-between periodic stressors, with price levels stepping up or stepping down slowly over time. Note how the moving average peaked near 33 during the bear market even though the indicator pushed up to To learn more, read: Short-term traders can lower VIX noise levels and improve intraday interpretation with a bar SMA laid on top of the minute indicator.
Note how the moving average grinds higher and lower in a smooth wave pattern that reduces odds for false signals. The price line can also be used as a trigger mechanism when it crosses above or below the moving average.
On long positions, a stop-loss would be triggered when the VIX moves below the prior day's day moving average on an intraday basis.
Note how the moving average grinds higher and lower in a smooth wave pattern that reduces odds for false signals.