With VIX futures, you can increase market awareness and make more informed trading decisions. Leverage VIX futures prices to choose the option strategy for you.
Futures on the CBOE Volatility Index (VIX) are becoming more popular with futures traders because they’re direct plays on the market’s volatility, or “vol.” And if you’ve traded /VX futures, you’ve likely run into the /VX basis. That’s the difference between the /VX future’s price in one expiration, say February, and the /VX future’s price in another expiration, say, March. You have to be familiar with the /VX basis, especially if you want to roll a /VX position from one expiration to the next, or when you’re deciding which /VX expiration to trade. To the untrained eye, the /VX basis can be confusing, so let’s give your eyes a little training and kick the confusion to the curb.
For other futures products, like /ES on the S&P 500, or /ZB on Treasury bonds, the basis is determined by the cost of carrying a position in the underlying. But the basis in /VX futures doesn’t have a carry component. There isn’t an underlying VIX to buy, which means there’s no arbitrage relationship that keeps /VX futures in different expirations in line. They’re free to move up and down. The confusion arises when one /VX is going up, while another’s going down. Why can that happen?
Calculating the basis can be relatively simple. First, subtract the price of the front-month /VX future from the price of the back-month /VX future. For example, if the February /VX future is trading for $13, and the March /VX future is trading for $14.20, the Feb–Mar /VX basis is $14.20 – $13 = $1.20. In this case, the $1.20 basis is positive, and it’s in contango.
If the Feb /VX future is $14, and the March /VX future is $13.50, the Feb–Mar /VX basis is $13.50 – $14 = $-0.50. The basis is negative (the back-month future is trading for less than the front month), and it’s in backwardation. The /VX can go from positive to negative and back again. But what does it mean?
Remember that the /VX future is the market’s expectation of what the VIX might be at the future’s expiration. And the VIX itself is the market’s expectation of what the volatility of the SPX might be over the next 30 days. So, the /VX can be thought of as a “future on a future.” As such, the /VX basis can indicate when in the future the market “fears” a potentially big price drop in the SPX. The market may be more fearful in the short term, narrowing the basis. Or in the long term, widening the basis. The /VX basis reflects the market’s opinion of what volatility might be at different points in time, which is why it can have big swings in price.
If the market anticipates a crash in the S&P 500 in the short term, the front-month /VX will possibly rally, maybe more than the back-month /VX. So the /VX basis will narrow, or may even go negative. This can happen quickly, sometimes intraday. Alternatively, if the market anticipates more volatility in the longer term, then the back-month /VX will possibly be higher than the front-month /VX, causing the basis to widen. If you’re bullish on the /VX and don’t have a specific time frame, you might consider buying the front month if the basis is very wide, or the back month if the basis is narrow or negative.
The narrowing and widening of the basis can be exacerbated close to the /VX expiration, when it converges with the VIX. For example, if the VIX rallies sharply right before /VX expires, the front-month /VX can rally sharply, too, and in a day the basis can go from positive contango to negative backwardation. That’s why it’s very risky to be short the front-month /VX, even if you’re long the back-month /VX in a calendar spread. It’s also why if you want to speculate on a rally in /VX, it could be advantageous to buy the front-month /VX if you think the selloff will happen quickly. On the other hand, because the price of the front-month /VX is usually higher than the VIX index, the front-month /VX can lose a lot of value quickly close to expiration, if it converges to a falling VIX. So, the front-month /VX future tends to be more volatile than the back month, and is often what drives the price of the /VX basis.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Thomas Preston is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
Futures and futures options trading is speculative and is not suitable for all investors. Futures trading services provided by TD Ameritrade Futures & Forex LLC. Trading privileges subject to review and approval. Not all clients will qualify.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2021 Charles Schwab & Co. Inc. All rights reserved.