Our community has grown substantially in the last few months with a particularly large influx of newcomers in the last couple weeks. I would imagine this is due to the fireworks we saw surrounding the recent rise in volatility and how we can both protect ourselves going forward as well as capitalize on any opportunities. I field a lot of email questions every day and usually it’s the newer people that are asking most of them. Today’s question will just be review for some of you, but a good number of questions this week were along similar lines to this one from Randy:
“It seems to me the markets are back to normal so can I buy SVXY now?”
Normal is a tough thing to define and every strategist is going to have a different viewpoint on what that means and which indicators they prioritize to determine it.
Since the VIX futures term structure gets so much attention in blogs and on Twitter (even though it’s not the most meaningful indicator) I will use that as a backdrop on why things aren’t quite what I would call normal just yet.
You can check the VIX futures term structure at: VIXcentral.com
There’s 2 things in that chart that stand out:
1) The VIX futures term structure is still in what’s called backwardation.
The normal state of the curve is that the front month future (furthest on the left labelled M1) will be the lowest price, and each months future moving to the right will be higher than the previous. This normal state (upward sloping curve) is called contango.
- Since VIX futures launched in 2004, the curve has spent 84.5% of the time in Contango and only 15.5% of the time in the current state of backwardation. Here’s an example of what a normal contango curve looks like, taken from January 2nd of 2018.
2) The VIX itself is still above the front month VIX future M1.
In the original chart at the top, the VIX index is represented by that dashed green line that says 20.36. You can see the front month future M1 is at 18.81 which is below the current VIX. The normal state of things is to see the VIX index lower than the front month VIX future, not higher.
- Since VIX futures launched in 2004, the VIX has spent 77.4% of the time below the front month VIX future.
Normal: 2nd month M2 > 1st month M1 > VIX index
Current: VIX index > 1st month M1 > 2nd month M2
So like I said this is a very narrow view of what’s normal considering the VIX futures are just one of several input variables in a comprehensive volatility strategy, but the answer to the original question is no it’s not a good time to buy the SVXY just yet. Patience is a virtue 🙂
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