Sunday, December 29, 2013

VIX futures market

The VIX is the ticker for the Chicago Board Options Exchange Market Volatility Index, which measures the level of 1-month implied (i.e. anticipated by the market) volatility in the S&P 500. It is constructed from a wide range of S&P 500 listed call and put options.
The exact definition is in this paper pages 3-9.

Below is a historical graph of the VIX since December 2006.

As with most popular indices, there is a futures market on the VIX.
A futures contract is a standardised contract between two parties to buy (for the buying party) / sell (for the selling party) a specified asset for a price agreed upon on the trading date with delivery / payment on the maturity date. These contracts are negotiated through futures exchanges, which act as an intermediary between the two parties, and requires the parties to post margin calls so as to neutralize any counterparty risk.
In the case of the VIX, there is one future per month, so that the first future maturity is never more than 1-month away. And the longest futures traded typically matures 9 month later. 

On a given day the value of these futures may / are likely to be different from the value of the VIX, as market forces (i.e. supply and demand) do not necessarily meet for all contracts at the same level.

In normal market situations, the short dated futures tend to be cheaper than the longer dated ones. This is know as a contango futures term structure, probably because there is little reason for a short dated futures to be too far from the VIX, while there is more uncertainty for long dated futures. There is more time for new to have and impact on market, and volatility is asymmetric. No news means no significant change to the current level of volatility while surprising news will almost always trigger a spike in volatility.

In distressed markets, the short dated futures are often more expensive than the longer dated ones. This is know as a backwardation futures term structure. In this case the market anticipates that volatility in the market will still be high when the short dated futures mature, while there is a reasonable chance that the temporary turmoil will be over or at least on the way out when long dated futures mature.

Naturally all flavors of intermediate term structure can happen in reality.

Any way, it is not easy to visualise the evolution of the market in time, as each date corresponds to a term structure. You would need a 2D surface in 3D to have all the information on a single image.
But then some parts of the surface might hide others. I did not think this would be very helpful. So instead I made a dynamic graph of the VIX futures term structure, from December 2006 (the market was embryonic before) to 24 December 2013.

You can see a reduced version (75%) of the web page below.
The code is in this github repo.