VIX Trend Remains Intact; Futures Repairing Structure

Last week I posted about a developing trendline on spot VIX. After touching it two more times in the last week, it remains intact. A brief dip below the trendline this afternoon failed and VIX rose to close above 11 yet again. The VIX has now been above 10 for 6 consecutive trading days, the longest that's happened since November 21, 2017.

The ongoing trend is unmistakable now and started January 4. Currently the trendline sits at about 10.8. Until that level breaks, one should assume that's the lowest VIX is able to go for now.

The VIX trend is putting mild upward pressure on VIX futures. Prior to the government shutdown, VIX did spike but futures did not rise nearly the same magnitude. This resulted in futures premiums narrowing a lot last week, and even briefly dipping into discount territory. One way to interpret this action is that futures expected VIX to drop again.

Despite a temporary resolution to the government shutdown, VIX did not drop very far. Now futures have a dilemma – do they rise to adjust to the new VIX readings? Or do they hold value continuing to believe that much lower VIX readings are on the horizon?

Generally, a synthetic 30-day VIX future tends to trade at about a 15-25% premium to spot VIX (when VIX is relaxed and relatively low). With premiums currently at about 10% it's an improvement over last week, but still narrow. In the event of another VIX spike, futures will have to cover some ground to the upside. In the event of a VIX drop, futures still don't have much room below to drop considerably.

For volatility traders with a short position, the risk profile is still not great, but it has improved since last week. Futures premium is modest but improving and contango is also stronger. To make the case for rising volatility, VIX continues a well-defined uptrend, and VXST:VIX ratio remains elevated near 1.

Looking ahead, if VIX stays around 11, futures can continue to slowly build up a premium by using contango to their advantage. UVXY and SVXY would not move much in that event, but futures could build up another 1-2% of premium by next week, putting less pressure on short volatility traders, and giving futures more room to the downside if VIX finally does break that trendline below 10.8.

If VIX rises much above 11, futures will no longer be able to absorb the rise through contango alone and they will have to start rising in absolute terms as well.

For now, short volatility positions should probably remain small, or limited to daytrading. Some great swings could have been had this week if 2-3% moves are your thing. Existing short positions could also be used to earn extra premium by selling covered calls (if long SVXY) or covered puts (if short UVXY). Timing these trades can be difficult though, and once volatility finally moves, you could quickly find either your covered put/call or your underlying position has moved significantly against you.

I suspect we continue to see choppiness overall. At some point the market will have to correct, and VIX will act accordingly. Until then, futures are trying to repair some structure by improving contango and treading water while VIX rises slowly. VIX does have a developing opportunity to break a trendline and drop lower, so the short trade could be in full force again soon, but we're not there yet. Watch your levels and position sizing, and happy VIX trading!