As someone who watches SPX volatility and VIX movement probably as closely as any blogger/educator this side of Bill Luby, I have to say I have been impressed by the ability of the VIX futures to hold up so well relative to the cash VIX. As the VIX has been getting crushed over the last few days, the May and June futures have barely budged. This is a chart of VIX Cash May and June since March Expiration:
Notice how the futures are decling at a snails pace over the last few days, despite the major VIX drop. As we all know, April is still trading. It would be the best way to trade the VIX if someone thought that the VIX was going to jump on either Monday or Tuesday. My assumption is that most of you are not going to be that brave. Here is the problem with trying to trade VIX cash with VIX futures or options. With almost a 4 point spread between May Future and VIX cash, I do not expect the May future (essentially the underlying for the options) to catch the first few ticks of an uptick in VIX.
Traditionally, the front month options have had a coloration to the cash of about .50 that may still hold true for the whole month of May. However, when the VIX is between 15-17% and the May Future close to 20, I do not expect that tight of a correlation. My guess would be almost 0 between 15-16 and maybe .25 between 16 and 17. It would be interesting to see some data on how the front month future and the cash correlate when the spread widens out like this.
The next question I often get is, "so what, how can this help me trade better?' Here is how:
For a speculator, this info is super valueable. If we study the spread between Cash and May and May and June one can see the risk associated of holding May options right now. If we simply sit here, May futures are going have to fall somewhat sharply over the next 30 days or so. Meanwhile, the June has less than half of that decline to make up. If we assume that the May isn’t going to catch most of the first upswing, I think speculative traders would be better served holding June options over May.
Another argument for this is the IV's of the VIX options since March expiration (the red is 30 day IV, the Yellow is 60 day):
Again, the front month is almost always more expensive than back month options, but with a loss of correlation, IV climbing, and a wide IV spread between May and June, the risks of holding a May option look even worse. Therefore, at least until cash can get up to 17.5, or VIX May IV falls back into the 70's I would strongly lean toward speculative bullish plays in June over May.
For those interested in using VIX as a hedge whether using the future or options, I would at least go as far back as June (maybe farther), as the risks above are bad for any May hedge. Yet, with SPX skew expensive, I think the VIX is a better vega hedge than owning puts.
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The VIX and the GVZ will be two of the Topic’s Jeff Augen (author of Trading Realities) and I cover during a Special Pit Report (for paying members only) on June 21st. If you have interest in hearing Jeff and I discuss VIX hedging, GVZ, and a whole host of other topics, sign up for our Level 1 Large Group Mentoring or higher ASAP.
This will also be one of the topics I covering this topic in the special webinar series ‘Trading ETF’s in a Volatile Market.” Register here.
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