Movement in the Term Structure

Last week, I cautioned you away from short volatility positions and we bought some CBOE Volatility Index (VIX) calls based on a quickly moving momentum signal. This week, we're getting some more confirmation of the significance of this market movement from the term structure of VIX futures.

Fig. 1. VIX Futures Term Structure
Source: CFE, Condor Options


This snapshot of the last four sessions of VIX futures trading shows that the term structure made a significant move on Monday. At the close of trading, the March contract was last offered about $0.15 higher than April. That's nothing cataclysmic. The rest of the curve was still contangoed, meaning that longer-dated contracts were priced higher than short term contracts. Additionally, a lot of the end-of-day volume in VIX futures has been driven for some time by ETN hedging - by market makers and share issuers hedging their exposure to VXX, UVXY, etc.

Even so, this sort of flattening in the term structure should be taken seriously. You shouldn't trade against this sort of movement; you should step aside and possibly let the front couple months backwardate in a meaningful way, taking that as a signal to be long volatility. Given the event-driven nature of these market swings, it's easy to imagine a huge selloff in volatility as soon as there is any political resolution in Italy, and with SPX ten-day annualized volatility below 20%, we're still obviously talking about trying to dodge the brunt of an ordinary correction, rather than the onset of a recession.

This isn't the kind of market where I think it makes sense to start building substantial new short positions, but we're also not interested in buying any dips or selling volatility here.

We have an open long position in VelocityShares Daily Inverse VIX Medium Term ETN (ZIV) that I like as a buy-and-trade position. We are long from $23.60, so we have a paper gain of about 21% there since late December. I want to keep those profits and we will plan on exiting the position on a close below $28 this week.

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