Jared Woodard Futures Trade: VIX

S&P 500 futures jumped eleven points Tuesday evening after it was clear that the House would not hold a vote on the plan Boehner had been working on; instead, expectations are that the House will vote on the Senate plan that had been worked out by McConnell and Reid. And sources were telling reporters Tuesday evening that the procedural nature of the bill that would be sent by the House would be such that a filibuster in the Senate would not be possible.

Right now, December the CBOE Volatility Index (VIX) futures have 64 days to expiration, or about two months, and were priced at the Tuesday close at 17.61. Compare the two-month realized volatility of the S&P 500 at 11.3%. Looking back at the relationship between two-month SPX implied and realized volatility since 2009, my analysis shows that the median ratio of those estimates was just over 1.15; the median difference was just over two points. Compare the December VIX and SPX realized vol estimates at a ratio of 1.56 and a difference of 6 points, and it's easy to see why the VIX futures look rich. Since we are comparing the price of VIX futures instead of at-the-money SPX option implied volatility, we should note that VIX estimates tend to be a little higher because the VIX methodology incorporates volatility skew. But the VIX futures are still in the top valuation quintile since the financial crisis.

Assuming there aren't any new snags on Wednesday, traders can position for a return to some normalcy by selling the December contract. The thesis is that even if Q3 earnings are disappointing overall, and even if the knock-on effects from the government shutdown harm expectations for Q4 GDP, the roll down effect alone will justify a short bias for this contract. There is also a seasonal tendency which should be felt more clearly in the weeks ahead - typically December VIX is priced a little lower on the curve than nearby contracts because of muted holiday trading.

Trade: Sell to open VIX December futures (VXZ3) at $17.61, or better.

Traders with smaller accounts can execute in the mini VIX contract (VM) and equity-only accounts can buy VelocityShares Daily Inverse VIX ST ETN (XIV). I suggest a half-sized position with the remaining portion contingent on the debt ceiling being raised.

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At the time of publication, Jared Woodard held positions in VIX options and futures.

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