Article #568) Market participants are confused! The VIX futures market agrees

Updated: Nov 3, 2020

VTS Community,

I saw a hilarious news headline on Twitter today and I just couldn't resist making a snide comment  (@volatilityVIX to follow me)

I think what struck me about it the most is that it so succinctly summarizes the confusion we're all feeling about this market.  One week trade deals are off, the next week they are going well.  One week the Fed wants to hold steady on rates, the next week they want to cut 50 basis points.  Oh they are going to take "actual" actions now are they?  Like they really really mean it this time, as opposed to before, only kinda maybe?  It's ridiculous! 

And the worst part about this market is, all the action is in the overnight session so for tactical traders there isn't even much opportunity to position correctly.  The whipsaw action this past 12 months is about the highest I've experienced since the financial crisis. 


Market participants are confused!

And I don't mean I just have a feeling that people are confused, or I get a vibe that they are.  I mean quantifiably so, it's showing up in many of the metrics I track.  Let me illustrate.

M1:M2 VIX futures contango since Jan 1, 2011:

* For anyone who wants to catch up on what M1:M2 contango means, I have a full explanation here.

So in the last 9 years, those front two month VIX futures have seen an average contango level of 6.00%.  Now side note, there's nothing special about Jan 1, 2011 other than it's the inception of my VTS Volatility Barometer so it's a common date for me to compare against.  But ok, about 6.00% contango during this bull market.

M4-M7 VIX futures contango since Jan 1, 2011:

* Again, for a full explanation on M4-M7 contango, you can check out my full article here.

So in the middle section of the VIX futures curve, out at the 4th - 7th month, you can see the average level of contango is a little higher in the last 9 years, at 6.88%. 

And this does make sense in the context of a bull market.  Those front 2 months M1 and M2 can move around a lot depending on the short term news events the market is going through.  But when market participants are more confident in the future, those short term events show up a lot less in the farther out M4 - M7 months of the curve.  Even when something spooks the market short term, there's no reason to expect it will persist for 4+ months right?  So in a "normal" market we expect to see a lot more consistency in the M4-M7 months.  

M1:M2 VIX futures contango for the past 6 months:

So in the last 6 months, despite a few rocky periods you can see M1:M2 contango is just about in line with long term averages, at 5.61%.  It's slightly below, but nothing that stands out as abnormal.

M4-M7 VIX futures contango for the past 6 months:

Wow, that does stand out right?  Not only has M4-M7 contango spent more time in backwardation, but the average contango level in the past 6 months has been just 1.66%. 

It's normally higher than M1:M2 contango with far fewer periods of backwardation.  But recently, it's switched.  The 4th - 7th months are where the weakness lies. 

What might this mean?

Well for starters, these news events that are bouncing the market around, resulting in the S&P 500 being at the same level today as it was 19 months ago in January 2018, people seem to be taking them more seriously.

Beyond that though, if front month futures are in line with long term averages, but farther out month futures are substantially lower, it means market participants are not expecting these to be short term one-off type events.  They likely view them as having some staying power, taking longer to work through.  And perhaps, if you want to go this far, maybe not being able to be worked out at all and a sign of an impending downturn.

Now I don't like to use the R word  (recession)  because it can be alarmist for no reason.  However, this isn't a small deviation.  This is a statistically significant divergence of VIX futures.  We haven't seen M4-M7 futures this weak since the financial crisis.

It's also showing up in the ETFs that track those futures.  Since the SVXY was deleveraged from 1x to 0.5x, it should track a lot closer in performance to the ZIV.  However we've seen a significant divergence here as well:

In the last 6 months, SVXY is only slightly negative, but ZIV is down double digits at -10.72%.  Again, this isn't something we see very often at all.

The VIX futures market is telling us something.  It's saying market participants are confused.  Again not a feeling or a vibe, the actual numbers back that up.  These are confusing times.  The algo's have been running the show in the overnight session for months now, leaving real living breathing traders to be whipsawed around.

Long time followers know exactly what I'm going to say the solution is.  It's to remain patient, quant based, and trade the math in front of us.  I have no idea where markets are going, and anybody who says they do is just fooling themselves.  But following my systematic strategies as if I'm a robot, taking the signals the Volatility Dashboard tells me to take, has never led me wrong in the past and I have confidence it won't this time.  I for one will be sticking to the process.  I'll be confused by the conflicting news headlines when I do it, but that's my plan none the less...

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