Visualizing The VIX Term Structure Over Time

Followers of the VIX ETPs know full well the importance of paying attention to the VIX term structure. While movements in the VIX alone can’t fully explain the returns one can expect from products like VXX, XIV, UVXY, and TVIX, when combined with an analysis of the term structure,  you get a clearer picture of what exactly is going on with these products (not a perfect picture, just a less ambiguous one). For those familiar with bonds and the fixed income universe, the analogy I like to think of is duration and convexity for changes in interest rates. As a single point estimate, duration can be a poor indicator of bond performance over large changes in interest rates. However, duration combined with convexity can give one a reasonably better estimate on bond performance for large changes in interest rates. So too, when one combines movements in the VIX with the current VIX term structure, you arrive at a more robust explanation of VIX ETP performance over time.

And here follows below a set of visuals that combine the two biggest drivers in VIX ETP returns: the VIX itself and the VIX term structure. I’ve broken out by year since 2007 how the VIX term structure has distributed over the course of a year by the difference in prices between the current front-month and third-month VIX futures contract as a simple estimate on the VIX term structure. I use these two months in particular simply because the balance of products on the VIX focus on the front two futures months (followers of the term structure should be able to back out that, being as concave downward as it is, the term structure will have a lesser impact on the intermediate ETPs like VXZ and ZIV). On each chart I’ve also shown the price change over the course of the year for both the cash VIX and also a buy-and-hold front-month VIX futures position (rolled the day before each expiration).


2007 Term Structure


2008 Term Structure


2009 Term Structure


2010 Term Structure


2011 Term Structure


2012 Term Structure

2013 year-to-date:

2013 Term Structure

I find the data set to be interesting because while the VIX term structure has an overwhelming propensity to be in contango, the distribution is not very uniform over time and can fluctuate wildly. I find that 2012 was probably one of the most extreme cases of the futures market in contango. It spent all of 1 day the entire year outside of contango conditions. Due to the severe degree of contango over the course of the year, 2012 represented essentially a volatility selling paradise of sorts, with only a minor blip in equity markets over the course of the summer last year. Bill Luby at VIX and More has done a similar piece looking at 2012’s term structure in comparison to the term structures of prior years. (If you are new to the VIX or in need of some insightful analysis on anything VIX-related, you need to check his site out.)

How has 2013 stacked up so far? Well it looks essentially like more of the same from 2012, if only to a lesser degree. Some might argue complacency in markets, and it could be a point well taken. In fact, you could argue that 2010 is an analog for what 2013 is shaping up to be. In that year, the VIX term structure was in steep contango for a few months before the Greek debt crisis really came to the forefront and the flash crash followed not too long thereafter. However, despite all the market mayhem that followed afterwards (including a 1,000+ point intraday drop in the Dow), the term structure came back to contango with a vengeance and the year on balance proved to be every bit as good for selling volatility as 2012. I guess time will tell if we can get a macro event able to tip this market over to the downside since we have already easily dismissed multiple macro threats to this rally like sequestration and the ECB’s  handling of the banking crisis in Cyprus.

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  1. Ryefield · · Reply

    While I admit not to fully understand your charting method, I find difficulties in your analysis because of the assumption that the returns distribution on a continuous (rolling) short position in front month contract is normal. Did you take into position the time it took, for instance, to regain all the money lost in July 2011 or Apr 2010? And that’s assuming none of those volatility peaks erased one’s account altogether.

    What I’m saying is, that due to the obvious tendency of volatility market to be in contango being short the front seems an obvious choice, but how COST EFFECTIVE is it, in dollar weighted terms? If you make $1000 a month for three years and then lose $50,000 the one time vol kick back with vengeance, it’s not a great deal is it? Especially at the $1,000 a point multiplier on those contracts.

    I would also suggest that this asymmetric risk to returns ratio applies even more in years like 2012 that you’ve mentioned, because cash VIX (and front contract) are so low.

    1. Thanks for reading Ryefield. Let me say you make some good points. To your point about non-normality, I couldn’t agree more. I don’t recall implying that the returns from a short volatility position are somehow normal (Gaussian) in a statistical sense, they are far from it. What I present here is more of a representative concept rather than a practical strategy. I don’t think one should simply short volatility all the time, there are times when it makes sense and times when it doesn’t.

      To your point about cost effectiveness, I see what you are saying, and it is certainly an issue depending on how one manages a short volatility position and the risk of that position over time. What you are seeing above is essentially a constant position sizing regardless of profitability. In your example above, if I have made $36,000 over three years, I am not including that $36,000 in my position size for month 37, it is still relative to the money I had to start with. If I include that $36,000 in my position size, then you are correct, it would not take a very large volatility spike to overwhelm all my profits and then some because I am now trading a larger position size than what I had started with.

      If you say, well how practical is that if you’re not reinvesting your profits? I would agree, these concepts are more representative of an idea rather than practical trading ideas. I do not intend this post as a “how to make money shorting vol” concept piece. Thanks for reading!

  2. Glad to see we’re on page. btw, you ispired me to open my own such “blog” or whatever they call it now.. and I replied to you reply there :). you’re more than welcome

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