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VIX Monthly Review – October 2017

With October just about in the books, let's do a review of where volatility went this month. October is typically one of the most volatile months of the year. For what it's worth, a 20 year seasonality chart shows the first week of October as the seasonal high for VIX, with an average of 24. This is in direct contrast to this year's action when the same time period saw the return of repeated sub-10 VIX prints. This certainly raises the question as to whether VIX seasonality applies in any way this year with VIX again near all-time lows.
VIX Seasonality, 1997-2017
In fact, the hourly chart of the month of October shows a slow but steady climb in spot VIX. After staying under 10 for the entire first week of October, VIX put in a low at 9.11. Since then VIX has seen a few mini-spikes. The first real spike of the month was on October 19 in the premarket session, before US traders even had a chance to wake up. A second and slightly larger spike put in the high for the month at 13.2 on October 25 then quickly retreated. Despite these spikes lasting mere hours, a trend emerged for the base of VIX with a slow but steady climb upward. On October 30, VIX finished at 10.5.

Contango is improving from its October 25 low,
VXST:VIX is a little cautious

The VXST:VIX ratio is one of my favorite indicators to help me determine if short-term volatility has the potential to spill over into the VIX and build into larger spikes. I won't go into a detailed discussion of this ratio today, but a good cutoff is seeing the VXST:VIX ratio stay below 0.97. Once it begins approaching and surpassing 1.0, it can often signal a runaway volatility scenario where short-term volatility starts fueling volatility into the monthly time frame. Overall the VXST:VIX ratio has increased over the last month. We even exceeded 1.0 briefly on October 25, and the term structure between November and December futures almost flipped into backwardation. But almost as quickly as the market began racing toward that inflection point, VIX quickly retreated and contango was maintained. The elevated VXST:VIX could signal caution for volatility shorts.
M1M2 Contango at a whopping 15% early in October.
The Nov-Dec Contango has been more muted until recently.

November-December contango started in the very low 4% range at the beginning of the month. At the time, contango between October and November futures was running at a very robust 12-14%, but whenever I see a lower contango period approaching, I get very cautious about carrying a large short volatility position as profits are likely to be slower in the future. This certainly confirmed this month as prices of volatility funds are essentially unchanged from 2 weeks ago. But November-December contango has been increasing since the October 25 spike, and December-January contango has consistently been a strong 8%+, so volatility shorts have that to look forward to in a couple weeks. It might be an indicator to start shorting volatility on upcoming spikes.

Overall, signals are a mixed bag for volatility right now. The VIX base is slowly rising, but the futures structure is still in contango and improving. VXST:VIX is elevated compared to the beginning of the month, but still in an acceptable range for volatility shorts. In a period such as this, it makes more sense to look at overall market action and internals to help me guide my trading decisions. Of course no one can predict exactly where volatility will be tomorrow or even a month from now, but there certainly appear to be some good trading opportunities coming up.

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