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The VIX Futures Basis: Evidence and Trading Strategies

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What they found

The authors studied the gap between VIX futures prices and the spot VIX (the basis) from 2006 to 2011. The VIX futures curve is usually in contango (futures above spot), and the basis strongly predicts the futures' subsequent return as they converge toward spot: a large positive basis is followed by futures declining. A strategy that shorts VIX futures when the basis is high and buys them when it is negative, hedged with S&P 500 futures to neutralize equity exposure, earned substantial returns, largely because the futures basis is a roll-yield that does not forecast changes in the spot VIX.

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Contango and backwardationTwo futures curves against contract expiry: one rising above spot, one falling below it.The same commodity, priced for delivery at different dates.78.0076.0074.0072.0070.00Futures pricespot+1m+2m+3m+4m+5m+6mMonths until the contract expiresspot price74.00CONTANGOlater contracts cost more than spotBACKWARDATIONlater contracts cost less than spot
Contango and backwardation. A futures curve shows what buyers will pay for delivery in one month, two months and so on. When later contracts cost more than the spot price the curve is in contango; when they cost less it is in backwardation.

What you can use

  • VIX futures usually trade above spot and drift down toward it; long VIX products bleed money in normal times because of this roll.
  • The size of the contango is the best predictor of how much a long VIX position will lose over the coming weeks.
  • Shorting VIX futures in contango is the source of the 'short vol' returns, and it carries catastrophic tail risk, as February 2018 showed.

Caveats

Sample 2006 to 2011; the strategy's later real-world implementations blew up in 2018. Hedging with S&P futures reduces but does not remove tail risk.

Tags: volatility, vix-futures, contango, roll-yield

Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.