Same VIX, Different Message

04/24/2013 8:00 am EST


Mark Sebastian


He has been closely watching the VIX curve over the last month for signals that this rally could end soon, and today, Mark Sebastian of revisits its curve structure for further clues.

One topic that consistently confuses people is VIX curve structure. It’s not just the level; it’s the slope that matters. Let’s look at two curves with very similar underlying VIX prices. I think the difference might be more clear.

On March 21, 2013, the VIX closed at 13.99, a mere .30% lower than where the VIX is trading. Also a very similar number of days to expiration across the different contract months relative to where we are trading today. Notice the slope of the curve in the front two contract months:

Click to Enlarge

The April future was trading at a one-point premium to cash, the May future was trading at a 1.25 premium to April. A steep contango. Over the next few weeks what did the market do? It sat in place or went up almost every day. Then last week happened and something changed.

This is the curve as of 3 pm EST.

Click to Enlarge

Notice that May is trading at a similar premium to cash, but that June is barely trading higher than May, only about .70. What does this mean? I think it points to how much the market has shifted in the last week. Traders think the cash VIX could go higher in the near term, but will probably hover closer to 15-15.5 than 14 or 18. That would explain why the curve would act this way.

I am also not in love with the VVIX being over 90, although that does point to some serious hedging activity.

The Trade
Right now, if we assume a stable VIX over the next few weeks, a SPX iron condor makes a lot of sense, so do some plays directly in VIX options or in VXX. Obviously, if the cash trades above June, I would NOT play VXX or VIX options, I still might do the SPX trade though. Even so, I would only be selling SPX condors at about 1/2 normal size right now and looking for good entry points as IV increases.When IV is fluctuating up and down, it does not pay to be hero, trade small.

By Mark Sebastian, Blogger and Contributor,

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