Bill Luby at VIX and More ：VIX futures rises more than 2.00 high

Courtesy of Bill Luby at VIX and More Truth be told, there is no such thing as a “contango bubble,” but I like how the two words look juxtaposed and it is Friday… Bubble or not, the VIX futures are stretched to an extreme that I do not ever recall seeing and to the extent that the grapevine is whispering to Adam Warner of the Daily Options Report that the differential between the first month and third month VIX futures is at its highest level ever. (Note to self, why doesn’t the grapevine ever whisper to me?) The chart below, courtesy of FutureSource.com, shows the difference between the VIX third month futures and front month futures (VX V0 – VX N0 in current VIX futures parlance) going back about six months. Personally, I tend to get excited when the third month VIX futures rises more than 2.00 higher than the front month, as this frequently suggests that the VXX negative roll yield contango play is starting to set up. Some 17 months after its launch, I probably still get more questions about VXX than any other subject. As much confusion as there is about VXX, I think it is probably time to come out with an extended look at this volatility product in the next week or two. Wednesday, August 4, 2010 Record Call Activity in VXX The iPath S&P 500 VIX Short-Term Futures ETN (VXX) saw record call volume yesterday, with over 49,000 call contracts traded (compared to 93,000 VIX calls.) VXX calls are active once again today with 25,000 contracts traded in the first two hours, compared to only 1,500 puts. VXX call buyers have yet to demonstrate that they are the ‘smart money’ when it comes to predicting the future of volatility, but this fact is obviously is not dissuading at the moment. Looking at the VIX futures, the second month futures are trading at 3.30 point higher than the front month, continuing the trend of 21 consecutive trading days with at least an 8% premium for the second month over the front month VIX futures. Call it the “contango rip tide” if you will. I mentioned the surge of interest in VXX calls a little over a week ago in VXX Calls Attracting Interest and wondered aloud whether “there is a little desperation in the air that may be triggering some revenge trades in VXX.” It is certainly not difficult to make the case for a rise in volatility from current levels, but with negative roll yield, time decay and other factors, that doesn’t necessarily mean VXX calls will be profitable trades if this turns out to be the case. For more on related subjects, readers are encouraged to check out: Bill’s response: It is not a signal to short VXX, though that is the position I currently have on right now. What it means is that the consensus is that the VIX has fallen too far, too fast. The VIX futures indicate that the market believes the VIX will spike back up into the 30s over the course of the next few months. My thinking is that it is more likely that the VIX futures will come down toward the current VIX level than the VIX spike back up to the level of the futures. Eventually the VIX and VIX futures converge at expiration. The question is which one moves the most in order to make that happen. The other important point (spelled out in the links) is that because of the contango in VIX futures, VXX will continue to lose value every day (like a leaky balloon), so VXX buy and hold positions will have to deal with a significant negative roll yield while they are waiting for the VIX to spike. I see the negative roll yield as comparable to time decay on short options positions or a daily dividend of sorts for shorts. Obviously, my opinion is in sharp contrast to the market consensus. I hope this helps. - Bill