Exploiting Term Structure of VIX Futures

Volatility trading has become very popular since the financial crisis in 2008 as investors started to appreciate volatility's negative correlation to common equity/commodity markets. It is therefore understandable that there is an increased interest in strategies which utilize the volatility premium. The easiest way to access this market is via liquid VIX futures contracts; however, there have not been a lot of academic research papers focused on this area. Luckily one recent research paper has come up with a strategy exploiting the volatility premium via VIX futures with really promising results.

Fundamental reason

Academic research states that volatility follows a mean reverting process, which implies that the basis reflects the risk-neutral expected path of volatility. When the VIX futures curve is upward sloped (in contango), the VIX is expected to rise because it is low relative to long-run levels, as reflected by higher VIX futures prices. Likewise, when the VIX futures curve is inverted (in backwardation), the VIX is expected to fall because it is above its long-run levels, as reflected by lower VIX futures prices.

Markets traded
Confidence in anomaly's validity
Notes to Confidence in anomaly's validity
Period of rebalancing
Notes to Period of rebalancing
Number of traded instruments
Notes to Number of traded instruments
Complexity evaluation
Complex strategy
Notes to Complexity evaluation
Financial instruments
Backtest period from source paper
Indicative performance
Notes to Indicative performance
per annum, based on cumulative 5-year gain from backtest stated on the page 18 (82 000$), calculated for starting account size 5-times the initial margin (56 375$)
Estimated volatility
not stated
Notes to Estimated volatility
Maximum drawdown
not stated
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Sharpe Ratio
not stated


volatility effect, volatility premium

Simple trading strategy

Trading strategy using VIX futures as a trading vehicle and S&P mini for hedging purposes. The investor sells (buys) the nearest VIX futures with at least 10 trading days to maturity when it is in contango (backwardation) with adaily roll greater than 0.10 (less than -0.10) points and holds it for five trading days, hedged against changes in the level of spot VIX by (long) short positions in E-mini S&P 500 futures. The daily roll is defined as the difference between the front VIX futures price and the VIX, divided by the number of business days until the VIX futures contract settles, and measures potential profits assuming that the basis declines linearly until settlement.The hedge ratios are constructed from regressions of VIX futures price changeson a constant and on contemporaneous percentage changes of the front mini-S&P 500 futures contract both alone and multiplied by the number of days to settlement of the VIX futures contract(see equation 3 on page 12).

Hedge for stocks during bear markets

Partially - Half of the strategy which buys VIX futures can be used as a hedge against equity market crises. The other half is short volatility strategy and therefore is absolutely not suitable as a hedge ...

Source Paper

Simon, Campasano: The VIX Futures Basis: Evidence and Trading Strategies
This study demonstrates that the VIX futures basis does not have significant forecast power for the change in the VIX spot index from 2006 through 2011 but does have forecast power for subsequent VIX futures returns. The study then demonstrates the profitability of shorting VIX futures contracts when the basis is in contango and buying VIX futures contracts when the basis is in backwardation with the market exposure of these positions hedged with mini-S&P 500 futures positions. The results indicate that these trading strategies are highly profitable and robust to transaction costs, out of sample hedge ratio forecasts and risk management rules. Overall, the analysis supports the view that the VIX futures basis does not accurately reflect the mean-reverting properties of the VIX spot index but rather reflects a risk premium that can be harvested.

Other Papers

Cheng: The Expected Return of Fear
Long investors in futures contracts on the CBOE Volatility Index (VIX), otherwise known as the “investor fear gauge,” lose 4% per month on average, paying this premium to hedge against periods of high market volatility. Even though there is substantial risk that the VIX rises further during these turbulent market periods, however, subsequent average futures returns are close to zero or even positive, rather than more negative. This phenomenon is predictable using real-time data on the slope of the VIX futures curve. Movements in price risk exposures and positions suggest that low demand for insurance from long investors drives this effect. A short futures investor who earns substantial returns during calm periods but otherwise pays out during VIX spikes can significantly reduce risk by moving into cash when the futures curve slopes downward with little detectable cost to expected returns, earning a 3.4% four-factor alpha per month with a Sharpe ratio of 0.36.

Johnson: Risk Premia and the VIX Term Structure
The shape of the VIX term structure conveys information about variance risk premia rather than expected changes in the VIX, a rejection of the expectations hypothesis. Remarkably, a single principal component, Slope, summarizes all this information, predicting the excess returns of S&P 500 variance swaps, VIX futures, and S&P 500 straddles for all maturities and to the exclusion of the rest of the term structure. Slope's predictability is incremental to other proxies for the conditional variance risk premia, is economically significant, and can only partially be explained by observable risk measures.

Mixon, Onur: Volatility Derivatives in Practice: Activity and Impact
We use unique regulatory data to examine open positions and activity in both listed and OTC volatility derivatives. Gross vega notional outstanding for index variance swaps is over USD 2 billion, with dealers short vega in order to supply the long vega demand of asset managers. For maturities less than one year, VIX futures are far more actively traded and have a higher notional amount outstanding than S&P 500 variance swaps. To the extent that dealers take on risk when facilitating trades, we estimate that the long volatility bias of asset managers puts upward pressure on VIX futures prices. Hedge funds have offset this potential impact by actively taking a net short position in nearby contracts. In our 2011‐2014 sample, the net impact added less than half a volatility point, on average, to nearby VIX futures contracts but added between one and two volatility points for contracts in less liquid, longer‐dated parts of the curve. We find no evidence that this price impact forces VIX futures outside no‐arbitrage bounds.

Donninger: VIX Futures Basis Trading: The Calvados-Strategy 2.0
I developed in a previous working paper the Sidre and Most-Strategy. The strategy relies on the typical termstructure of VIX futures. The Calvados is a refined and condensed version of these strategies. The starting point was a paper of Simon and Campasano. The authors demonstrate that the VIX futures basis does not have significant forecast power for the change in the VIX spot index, but does have forecast power for subsequent VIX futures returns. It is especially profitable to short VIX futures contracts when the basis is in contango. The original Calvados working paper presented improved metrics and parameter settings of the Simon&Campasano approach. The current working paper improves the original work in several points and extends the historic backtest. The overall patterns of the original results are reassured and improved upon. The Calvados is traded in the Sybil-Fund. It is so far the pick of the bunch. One gets a lot of fun for a medium dose of risk.

Donninger: Selling Volatility Insurance: The Sidre- and Most-Strategy
This working-paper examines and improves a VIX-Futures calendar-spread strategy proposed in the literature. The strategy relies on the typical term-structure of VIX-futures. Additionally a naked short-selling strategy is considered. The strategies have similar characteristics to selling Puts on the S&P-500. There is some risk, but also a lot of fun. The strategies are an interesting alternative investment-vehicle to boost the performance of a fund.

Donninger: Forecasting the VIX to Improve VIX-Derivatives Trading
Konstantinidi et. al. state in their broad survey of Volatility-Index forecasting: "The question whether the dynamics of implied volatility indices can be predicted has received little attention". The overall result of this and the quoted papers is: The VIX is too a very limited extend (R2 is typically 0.01) predictable, but the effect is economically not significant. This paper confirms this finding if (and only if) the forecast horizon is limited to one day. But there is no practical need to do so. One can - and usually does - hold a VIX Future or Option several trading days. It is shown that a simple model has a highly significant predictive power over a longer time horizon. The forecasts improve realistic trading strategies.

Hypothetical future performance

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