Things, it seems, are still looking a bit funny in the world of VIX futures.
Pragmatic Capitalism, for example, wondered on Thursday why it was that volatility futures were refusing to revert to the mean. It’s a point that has also been picked up by the Vix and More blog.
The focus here is on the spread between the index and both its near-term and mid-term futures contracts. The price of these contracts is currently ascending into the future, resulting in a contango curve structure.
As Pragamatic Capitalism notes, even though the VIX index itself has declined some 15 per cent this week, and even though VIX futures have followed, the basis itself is refusing to budge:
The front part of the curve fell quickly along with the VIX, but the months further out remain stubbornly high.
The gap between the VIX Index and the 2nd month of VIX futures is at 6.86%, which is just off the absolute 6 year high of 7.46% established on August 6th. This gap cannot persist forever.
And here’s the chart:
Of course, as we have noted before, there is one factor that many commentators could be overlooking when assessing VIX futures — the influence of iPath’s VXX short-term Vix ETN, which launched in January 2009.
As readers can see below, the spread’s general widening does coincide with the moment the VXX was launched:
Naturally, correlation does not equal causation, but it is worth pointing out that VXX has from the onset displayed very similar characteristics to the USO and UNG ETFs — the former of which is now known to have been the target of high frequency trading strategies focused on exploiting the product’s contango.
As Michael Johnston over at Daily Markets has pointed out before:
While the asset class exposure is very different, VXX is very similar to UNG in several ways; both products have seen waves of cash inflows despite delivering disappointing share price performances.
Since its inception in January 2009, VXX has seen cash inflows of approximately $2 billion, including more than $800 million in the first quarter of 2010. But VXX’s assets at the end of the first quarter totaled just $1.2 billion, the result of a woeful share price performance over the last year and a quarter. Since its launch VXX has lost more than 80% of its value, making it the worst-performing non-leveraged and non-inverse ETF over that period.
And much of that is down to the contango that afflicts the VIX curve at the moment. Writes Johnston:
So it’s important to realize that while the correlation between the value of VXX and the level of the CBOE Volatility Index will generally be very strong, VXX won’t respond perfectly to changes in the spot level of the VIX. Again, a similar lesson could be learned by examining UNG’s performance relative to spot natural gas prices; the “roll yield” has frequently made a greater contribution to total returns than movements in gas prices.
And if WTI and Natural Gas futures are anything to go by, investors should expect the VIX curve to stay in a stubborn contango structure for some time yet.
Or at least for as long investors continue to pile into the VXX ETN.
Related links:
Is something really scary coming in October? - FT Alphaville
Vix-ated - FT Alphaville