Trends in VIX Settlement

CBOE Volatility Index (VIX) options and futures expire this week on Wednesday. This is a once a month opportunity for traders to get a clean look at how VIX options and futures function. During this five-day period the VIX really shows how the different months interact with each other, what happens to a contract when it moves from 'out month' to front-month future and the process by which a future moves from trading at a premium to settling into cash. If you are unfamiliar with VIX derivatives, this is the week to watch the VIX options and futures move.

Lets start with the contract that is settling. May is currently trading at a $0.70 premium to cash, assuming there is some weekend adjustment, that number will open up around $0.30 today and widdle down to $0.10-$0.15 tomorrow. Traders often lament there is no way to 'trade the cash VIX.' Over this two-day period VIX futures and options get as close as one can get in the list market to trading like the cash VIX.

When VIX settles on Wednesday pay attention to where the VIX is trading on the open, and where the VIX actually settles. Also, notice the number of weird far OTM options that trade $0.05 on the open as well. Depending on how many of these OTM options trade the VIX will either settle near the cash, well below or well above cash. It's a convoluted settle, but interesting to watch.

Next up, watch the out month become the front-month future. Over the next five days, the June future will truly begin "slipping off the slope." As traders move into shorting it in anticipation of the Future converging with cash VIX. The first week of a futures life as the front month can have some of the strongest decay. Playing June on Monday or Tuesday as a short regardless of any May play is known to be a favorite of prop traders. June is going to have a bit of a blood bath this week. The rest of the curve will also shift with June and a new month will be added. The curve will manage to hold its current shape even as May rolls off. This means that actually ALL of the months will see some increase in decay this week, not just June, however it's the most significant in June.

If we see June take its expected dive that is also bad news for iPath S&P 500 VIX ST Futures ETN (VXX). The ETN, which we know has problems, typically performs at its worst during these weeks. It is when its most concentrated in the front month future and also when the front month future dives. This is not good forVXX. There is less of an affect on some of the other ETNs, however, my guess is they will also see similar issues to VXX.

It's also buy-write Monday in options world. This is when many funds and individual investors move to execute buy-write strategies in June options. This can have a negative impact on SPX options, so look for VIX cash to see some pressure early Monday from this effect We would see it if VIX is up far less than its normal .60%-.70% that we normally get on a Monday.

The week after expiration is a great time to learn about premium flows and how things become oversold (or over bought) take some time this morning to really watch how the VIX moves. Continue to watch the rest of the week paying special attention to cash, May and June's relationship.

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