Longest Streaks of VIX Futures “Contango” and “Backwardation” – Rankings

by | Sep 19, 2016

 

  • Contango is when the VIX futures term structure is upward sloping  (2nd month future is greater than the front month)
  • Backwardation is when the VIX futures term structure is downward sloping  (front month future is greater than the 2nd month)

 

The volatility ETN’s XIV and VXX don’t derive their price based on supply and demand like regular stocks do.  Instead, their price is derived based on a system of rolling the front two month VIX futures contracts every day.  So the shape of the VIX futures term structure is of vital importance to the performance of the products themselves.

Volatility traders attempt to be allocated in the XIV during the strongest periods of contango and allocated to the VXX during the strongest periods of backwardation.  Now that’s obviously easier said than done because by the time you look at the term structure it’s already influenced the price of the ETN’s, but that’s why successful strategies have to be predictive in nature.

So here’s a look at the longest streaks of contango and backwardation:

 

As you can see, periods of contango are far more frequent and much longer in average duration than periods of backwardation.  Since the launch of the XIV the VIX futures term structure has been in contango 87% of the time.  However it’s worth noting that although periods of extended backwardation are few and far between, when they do come the losses in XIV can pile up extremely quickly.

This is why safety is paramount to any successful trading strategy, and why our VTS Tactical Volatility Strategy focuses exclusively on risk management and reducing drawdowns to the lowest possible level.

Following the shape of the term structure can lead to very large, very easy profit as we’ve seen so far in 2016.  But without a comprehensive and fully risk averse strategy, it’s only a matter of time before the term structure walks you right in front of the freight train.

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