VIX Futures Curve back to New Normal

The VIX futures curve shows the current expectations for stock market volatility over time. The chart below shows the curve over four different points in time:

  • The green line was from the height of the Eurozone crisis in 2011
  • The red line was the curve as of 10/15/2014, the date of the Bullard Bounce.
  • The blue line is the current VIX futures curve
  • The purple line is as of 9/3/2014, right before the current instability began.
source: CFE

source: CFE

This chart highlights several of the features that characterize VIX futures markets:

  • When the overall level of the VIX is high, as it was during the Euro crisis 2011, the curve flattens almost completely; the curve converges at the same price
  • During times of complacency, such as the blue and purple lines, the curve slopes higher. This represents what Artemis Capital calls a “bull market in risk.” Traders are seeking long term protection against stock market decline. This stems from the forced over-allocation to equities brought about by successive QE regimes.
  • The front of the VIX curve is much more volatile than the back end; notice how the curve inverts as of 10/15/2014. This also means the front end has a higher correlation with the spot VIX. The back end is most affected by changes in the long term mean of the spot VIX.

While the October market decline was severe, this chart shows that rises in the curve were mild compared to 2011. This is especially troubling given the proliferation of short VIX futures ETF’s which stay perpetually short the front end of the VIX curve.

The current shape of the curve indicates a general complacency in the stock market. Traders will be watching the curve closely for the early signs of inversion, a classic indicator of impending market turmoil. 

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