The spot VIX was trading at 14.17 on Friday, according to CBOE.com. The September VIX futures were trading hands at 18.75, or a premium of about 32%.
Is spot VIX telling the truth?
According to the CBOE’s definition, the VIX is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.
Some are interpreting a VIX hovering around 14 as a sign of complacency, The Wall Street Journal reports. “But a low VIX doesn’t mean that traders have stopped buying protection or are overly confident in price increases. It just means the price of puts and calls—options that profit from falling and rising prices, respectively—is low,” the newspaper said.
A recent Barron’s report explained the difference between spot VIX and derivatives based on the index.
“Everyone talks about spot VIX…but VIX futures tell the real story. VIX futures, compared with spot VIX, are extremely expensive, even though it is common to hear people say the VIX is so low that it indicates investors are complacent and perhaps suggests a short-term market correction is imminent,” Lawrence McMillan wrote for Barron’s.
He points out it’s impossible to trade the spot VIX that investors see quoted. Traders paying far in excess of spot VIX levels for VIX futures that expire in coming months is further evidence that the stock market rally has few believers, he added.
‘Hated rally’
Much of this VIX futures buying is a direct result of the heavy demand for VIX exchange traded notes, primarily VXX, McMillan said.
“Heavy investor demand for VXX creates heavy demand for VIX futures. This, in turn, sharply boosts VIX future prices, telegraphing another contrary indicator,” he wrote. “When the investing and trading public start believing in this rally, the put-call ratios will start to reverse and the term structure of the VIX futures will flatten. Only then will it be time to sell stocks. Until then, the market—hated as it may be—can continue to march upward against this tide of negativity.”
iPath S&P 500 VIX Short Term Futures ETN
Full disclosure: Tom Lydon’s clients own TVIX.