VIX Futures Signal IV Likely to Continue to Rally
Today, as the VIX rallied past 20, the cash VIX and August future began to enter backwardation:
As you can see, VIX August futures closed around 19.60, while the VIX cash settled at 20.23. Some traders have made comments that sometimes this can be a sign of a top in IV; I personally do not think so. I actually think there is a lot more slack in implied volatility and expect it to rise as the US Debt situation becomes an all out crisis. In the Greek crises, the VIX reached a top of 24.5% and settled over 22.5 on June 16th. We can learn a few lessons from that day that might have signaled a panic. Here were those signs:
1. The VIX had a very wide INTRADAY range. It not only closed high, it had a spike in its price intraday of almost 10% of its value.
2. The VIX cash did not just enter backwardation with July, which was the front month. It got into backwardation with August as well. This was a real sign buying in the immediate.
Those two points basically mean that any measure of short term future volatility is trading well below current volatility. This implies the market now has greater expectations of the IV going down in the next 30 days than going up. The only other piece of the pie I would want to see, something we saw in March during the Japan crisis, would have been to see July VIX futures trade over August VIX futures. That to me would have been the sure fire sign that VIX was heading back down.
As stated above, today we did see VIX cash get above August; however, it has not rallied past September yet, and we also have yet to see a day where VIX makes a wild intraday move. Based on where the VIX is currently trading, I think in the next few days we will see an increase of at least 4 points in implied volatilit, coupled with a 20-30 point drop off. This would be followed by 1 more day of major movement, with a morning AM VIX panic where the VIX touches 27-29%.
If a deal is not done by August 2nd, that is when the real fireworks begin. On August 3rd the VIX futures fully backwardate (is that a word?), and the VIX finally breaks 30% for the first time in a year. This is likely caused by traders scrambling to cover CDS’s and bond exposure. I believe this scenario is highly unlikely; however, it is interesting to think about what happens if a deal really isn’t done. VIX of 30 puts the SPX close to 1200.00. I will also be selling every put I can find at that point.
That type of panic is what forces congress into action and gets a deal done. It is also what makes a smart trader some money. As we break 25%, it could be some of the best opportunity to sell premium we see for the rest of the year. The key is to be patient, like a lion, a Venus fly trap, or a snapping turtle.....of course that all this goes out the window if a deal is signed.
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