One of the things I am constantly trying to explain to my option mentoring students is what the VIX really represents. Many people like to call it 'the fear' index, or pitch it as a true measure of market volatility. The truth is, it isn't. There are a few things I don't like about it.
1. The calculation keeps it consistently too high
2. The index is price sensitive
3. It is reactionary and not forward looking
Number 3 is the one that throws people off, they say, wait the VIX is a measure of IV, isn't IV forward looking. Yes, IV is, but the VIX isn't. Because the VIX does not reference price, or strike, takes into account skew, and is affected by price it is actually a more reactionary index then a forward looking index. This is one reason why the VIX Futures seem to be a better product for forward looking volatility. For instance:
It was last Tuesday in my nationally published article that the noted that the VIX broke below 16, and the FEB VIX futures though were priced at over 18.00 at the time (PS I hope you took this trade off already as it was a nice winner at several times in the past week). A premium of over 2 dollars to the Cash VIX. This is why I was surprised by what I saw today. Based on the combo value below, with the VIX priced closer to 17 than 16, the VIX futures were only trading around 17.50 at days end, less than 1.00 of premium to the cash. While I am not an expert, annecdotally, this seems tight with this much time till expiration.
While there are some time decay factors that come into play here, the fact that the VIX futures are lower than they were last week, while the VIX itself is higher says something. This tighter spread and lower future price suggests that the market is not worried about any type of near term pop in SPX implied volatility, at least for the next few weeks.
How can traders use this knowledge?
1. When the market is expecting nothing, if a vol shock happens it is more likely to catch people off guard, thus also increase how much IV will move-buy insurance in either the VIX or in Units
2. I think income trades with a tight defined risk make sense- the butterfly might be a good trade right now
3. Despite 'low IV" IV might be too high-look for the VIX to test 15 again.
4. Do not be looking for any blowout moves from any of the bell weather companies that still have left to report (e.g. MSFT, AMZN).
5. VIX as a short term insurance product is not a bad deal right now. VOL players should get better front month future correlation on a VIX bounce than they are used to.
I think point 1 is an especially important one, do not forget it.
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Data from livevol.
