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VIX Futures: Rolldown Vs. Absolute Levels

Trading in VIX futures can be extremely complex.  The shape of the VIX futures curve is constantly changing and can go from being completely flat to inverted to incredibly steep in a fairly short period of time.  Establishing long positions in VIX futures through exchange traded notes can be very expensive over time as your position is eaten away by the carrying cost created from the rolldown effect of a steep curve.   The short-term ETN’s such as VXX, TVIX, VIXY, and UVXY are notorious for this dramatic time decay because they suffer from the fact that the short part of the VIX futures curve is much steeper than the long end of the curve which directly turns into a higher roll cost.  To hold a long-term position in any one of these ETN’s can be extremely expensive.

Let us take a step back and look at the VIX futures curve in its entirety:

The curve is extremely steep for VIX buyers with nearly 10 vol points between the November and March contract.  On the short end of the curve you would realize dramatic roll down losses and on the far end of the curve you are purchasing the VIX at levels of 26%+.  Neither long strategies seem like a good idea.

What about that March contract?  At a level of 20.65%, just how much lower can it go?  The lowest VIX level on record is 9.3.  The lowest VIX level since the beginning of 2008 was 14.62%.  Maybe the contract expires in just a few weeks on March 21, 2012, but I like the asymmetric bet.  If I want to be long VIX futures, I like being bounded by a floor on the downside with tremendous upside should the bottom fall out of the market as it has done every year for the last three years.

A further thought is to use written call spreads on the steepest part of the curve to fund the March hedge.


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