What is the fair value of a Vix future? In truth, it’s actually pretty hard to say.
This is a point FT Alphaville has raised before of course — whilst pondering some other volatility-related issues, like the current elephant in the room that is Vix-related ETNs (arguably tramping about on the supply and demand balance of the Vix curve), and the question of why spot volatility remains so stubbornly low while longer-dated volatility and variance pound higher.
The question of whether volatility is an asset class in its own right also comes into play.
As Theo Casey of Futures and Options World has discussed before, it’s actually impossible to replicate the Vix, making convergence arbitrage rather an impossibility. And as Chris Cole of Artemis Capital Management has reminded us, there’s no denying the fact that Vix futures are and always will be derivatives of derivatives, meaning they’re at least twice removed from any underlying fundamentals.
So does this make them extra susceptible to reflexivity and the feedback loop? Many argue yes.
The fact that there isn’t really a single model for valuing a Vix future, or forecasting its own volatility, also turns the whole valuation of the futures curve into an even greater guessing game — because variable inputs from multiple different models equal something like one big pin-the-tail on the donkey game, we would say.
No wonder academics have struggled to make sense of previous pricing behaviour in Vix and products like Vix options, with many concluding that even the most logical and frequently used models must be imperfect or being applied to inefficient market prices.
But, says an outfit called Oakshire Financial on Wednesday, there’s also one more issue to consider. The fact that the Vix is not really a useful metric for technical analysis either.
As they note:
Performing technical analysis on the VIX is more a rogue’s game than honest trade, in our opinion, though there are some who swear by it. For our part, the facts inveigh against traditional charting of volatility indexes. For one, these indicators are derivative phenomena in the truest sense – they gives readings as a function of option prices, which are, in turn again, a function of the price of an underlying index, in the case of the VIX, the S&P 500. We say that makes it just a couple of steps too far removed from actual buyers and sellers to be used as an object of charting. It’s also plainly not a security. The bars or candles you see on a VIX ‘price chart’ do not represent anything that even approximates the chart of, say, Exxon Mobil – or any other stock for that matter.
And that means that any and all attempts to draw trendlines or apprehend ‘breakouts’ or analyze Relative Strength numbers or Stochastics, etc. have to be taken with a grain of salt.
Oakshire actually concludes it’s better to look at the Vix directly for a view of what might happen next rather than apply technical trend lines.
On that basis they say:
With the VIX literally toying with 52 week lows and investor sentiment at multi-year highs, and with the bond market pricing in a possible defensive outlook on the part of global investors, and all of this in the face of a Quantitative Easing regimen that looks not to be continued beyond June, we say volatility is about to go gangbusters and what you’re seeing now is just the calm before the storm.
But the point, of course, is that not even technical analysis may be able to help an investor accurately assess the current value of the Vix.
Let alone a Vix future.
Related links:
Vix wagging – FT Alphaville
Bernanke’s genie released – FT Alphaville
Why is the Vix so low? – FT Alphaville
Volatility as the new Black-Scholes – FT Alphaville