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By Lawrence G. McMillan
Source: CFE-CBOE

Economic and technical worries have seemed to keep VIX at generally high levels for the entire last month. VIX has generally remained above 30 since first breeching that level in early August 2011. Each time VIX has retreated to the 30-31 level, it has jumped even higher, as the S&P 500Index (SPX) declined.

The September VIX settlement price was 33.72, only about a point higher than last month. This is the first time that the settlement price has been above 30 for two consecutive months since March-April, 2009.

Figure 1 shows the entire history of the monthly VIX settlement prices, since the inception of futures trading in May 2004 (trading first began in March, 2004, and the first contracts that settled were the May, 2004, futures). The symbol for the monthly settlement price is VRO. The S&P 500 Index (SPX) is also overlaid on the graph. While there is not a perfect (inverse) correlation between SPX and VRO (and, by inference, VIX), one can see the general tendency of the two to move in opposite directions.

Previously, VIX has quickly rallied each time that it declined to the 30-31 level, which is shown on the chart in Figure 2. These lows in VIX have logically coincided with peaks in SPX. Thus declines in the 1200-1220 level on SPX have been accompanied by VIX trading down to roughly 30. Until this changes or until VIX clearly breaks below 30 these levels can be considered warnings of market tops.

Conversely, VIX has spiked up to highs in the mid-40's on four separate occasions since early August. Each time, VIX retreated off those spike highs and the stock market had a short-lived, but tradable rally. It is currently in the 40’s for the fifth time, but as of this writing, it has not reversed back down into a short-term buy signal for the stock market. That would occur if VIX falls to 38 or lower in the coming days.

Premium and Term Structure

Table 1 shows the state of the VIX futures term structure on September 23rd. All of the contracts are trading at a discount to VIX. These discounts are smaller than we saw a month ago, but the fact that all are at discounts is symptomatic of an ongoing bearish trend in the stock market.

The term structure slopes downward steeply in the first three months (October through December). After that, it is relatively flat out through May. The term structure has retained this relationship for nearly all of the previous months. It is bearish in that the term structure slopes downward, but the flatness in the later months is a bit unusual. As we mentioned last month, this continues to be the first persistent inversion of the term structure since March 2009.

Ironically, VIX jumped sharply higher just after September expiration, almost exactly as it did in August. The discounts on the futures are smaller this time (especially in the front month), so holders of October VIX calls and futures are getting most of the movement that is happening in VIX. That was not the case in August, when even the front month was trading at a 7-point discount to VIX.


The term structure spread trade that we often talk about is a viable strategy for this market. Currently the spread between November and October futures is 3.15. As VIX rallies, that spread widens, and as VIX declines, that spread shrinks. With VIX near 30 (its recent lows over the past seven weeks or so), the spread between the two front months has generally fallen to near zero (i.e., Oct and Nov futures are trading at the same price in that case). Conversely, when VIX rises in the mid-to-high 40’s, the spread widens out to more than four points.

Remember, there is extreme leverage in this spread. The margin requirement is only $625 per spread, but the movement is $1,000 per point. So if you bought the spread at –4.00 and sold it at zero, that would be a $4,000 profit.

Aggressive accounts can consider these spreads:

With VIX near 30:
Buy October and Sell November, for prices close to 0.

With VIX in the mid-to-high 40's:
Buy November and Sell October, at prices of 4.00 or higher (Oct over Nov).

Source:  Futures in Volatility: Market Summary and Analysis 9/27/11