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Is This The Most Successful Trade Of The Last Decade?

If the longs use VIX products as hedging instruments, then why would anyone take the other side? Especially in light of the fact that, as we discussed previously, only 1 in 20 "skilled" traders profit from VIX ETFs.

Because, being short volatility can be very profitable, according to Goldman. Year-to-date this short vol index is up 56%, and selling the front-month VIX has earned a massive 114 vol points...

The Short Story:  Short VIX futures index +56% ytd;  If the longs use VIX products as hedging instruments, then why would anyone take the other side? Because, being short volatility can be very profitable. The S&P 500 VIX Short-term Futures Daily Inverse Index (SPVXSPI) tracks the profitability of being short a constant maturity 1m VIX future and is the benchmark for ETPs such as the XIV and SVXY. Year-to-date this short vol index is up 56%.



In low vol environments VIX futures tend to trade above VIX spot and futures typically roll down the curve to settle at VIX spot.


Short VIX futures strategies profit from the contango in the VIX futures curve. The steeper the VIX term structure, the higher the (futures-spot VIX) basis, and short VIX strategies tend to be profitable as futures roll down the curve. There are many investors who try to profit from this well publicized phenomenon: sell a VIX future, capture roll down, do it again (wash, rinse, repeat).


Prior to VIX Weeklys if you wanted to capture the roll-down you might have sold the front-month contract and hoped for the best. Short vol investors know that putting all of your eggs in one basket can be a risky strategy.


VIX Weeklys may provide more flexibility with investors positioning for the roll-down a bit week each week by simply spreading out their monthly trades. Instead of selling $100 on the front month VIX future an investor might sell 1/4th of the notional per week which may help smooth the return profile. The VIX often mean reverts quickly so if one contract expires in the red, the other contracts may pick up the speedy mean reversion and end in the green.


On the tactical side, we could see more investors positioning for a swift decline in volatility post an event (FOMC for example). 

Shorter-dated VIX futures track VIX spot more closely

A one-month VIX future has a beta of 0.44 to the VIX. For example, if the VIX moves up a vol point, a future with one-month left to expiration tends to move up a little less than half as much, or 0.44 vol points.


Higher betas for shorter-dated tenors. The beta between a future with one week to expiry and the VIX has been 0.64 or 1.4x higher than a one-month future and 2.2x more sensitive to VIX moves than a future with three-months remaining to expiration.


Many exchange traded VIX products are benchmarked to constant maturity VIX futures. As a cross check on our reaction function we create constant maturity one- to six-month VIX futures each trading day and estimate the betas back to VIX changes.  The results are very similar, with a constant maturity one-month VIX future having a beta of 0.45 to VIX changes and threemonth futures at 0.27, very close to what our reaction function would have predicted (1m: 0.44; 3m: 0.29).




Shorter-dated VIX futures track (have more manipulative leverage) the market more closely...

The beta between daily changes in the VIX and daily S&P 500 returns has been -1.2 using data back to 2004. A beta of -1.2 implies that for every -1% decline in the S&P 500 we would expect the VIX to go up by 1.2 vol points (say from 15 to 16.2).


The beta of a one-month VIX future to S&P 500 returns is -0.60, roughly one-half the sensitivity between the VIX and market returns; about 1.5x that of a three-month future (-0.41) and 2.1x a six-month future (-0.28).  We make two important points here: (1) you cannot trade spot VIX and the betas between the tradable VIX futures and the market have historically been much lower; (2) the betas fall off dramatically as you move further out in the term structure.



As a VIX future approaches settlement, its sensitivity to S&P 500 returns grows exponentially. The beta of a VIX future to S&P 500 returns moves from -0.6 on a one-month future to -0.74 on a two-week and -0.86 on a future with one-week left before VIX settlement and -1.15 with one-day left to maturity which approaches the beta of VIX spot (-1.2).

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So - in summary - being short vol has been among the best performing trades of the last decade (never mind the risk-side) and, the introduction of weekly VIX futures (and the exponential decay implied by these volatility-inducing instruments) offers, according to Goldman Sachs, even more opportunity for active risk takers to sell vol, scrape premium, and face unlimited downside risk... playing the contango collapse game until there are no more musical chairs left.