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Chart In Focus

VIX Well Below Its Futures Contracts

Chart In Focus
September 29, 2016

When there is a big disagreement between the value of the spot VIX Index and the prices of its futures contracts, that carries important information about trader sentiment.

As of the close on Sep. 28, 2016, the spot VIX was well below all of its futures contracts.  The chart above measures the spread between the spot VIX and the highest priced VIX futures contract, which is currently June 2017.  The direct message is that VIX futures traders do not think that VIX value in the 12s is likely to persist all the way until the futures expiration.  The image at right shows a recent quote window.

VIX futures quoteWhen the spread gets this big, it can be a sign of excessively complacent trader sentiment about the near term risk picture.  The VIX Index is calculated based on the volatility premium that gets priced into SP500 Index options.  When traders are complacent, they drop the price of insurance, much like a homeowner’s insurance company reduces policy premiums in Florida when there have not been any hurricanes for a while. 

A VIX futures contract, however, is priced based on whatever a trader is willing to accept to buy or sell that futures contract.  Since there is no physical product like in gold or corn futures, the VIX futures are settled for cash at the value of the spot VIX Index on contract expiration day. 

If the VIX really were to stay in the 12s all the way until June 2017, then a futures trader who was short the June 2017 VIX futures contract could make a lot of money as prices eventually decay back down to meet the spot.  But the VIX tends to wander around a lot over a time span like that.

The chart above may not adequately portray the full context of the recent high spreads between spot and the highest futures contract, so here is a longer term look.

VIX spread from highest VIX futures contract

It is pretty rare to see the spread get up as high as it has recently, and when it does happen, there tends to be a meaningful selloff in stock prices in order to restore a healthy level of worry into the hearts of overly bullish speculators.  I expect to see the same outcome this time. 

Tom McClellan
Editor, The McClellan Market Report

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