Contango, Backwardation, and VIX Futures

Contango and Backwardation are two terms thrown around by traders when referring to the futures markets. These terms refer to the shape of a curve that may be created using the prices of contracts expiring over different time periods. An example of contango is represented by the blue line on the chart below and the red line shows what backwardation would look like. So why is this important?

Well, when the VIX curve is in backwardation this represents a situation where the marketplace is anticipating lower implied volatility in the S&P 500 index option market in the form or a lower VIX. The VIX and S&P 500 move in opposite directions the majority of trading days. Therefore, if the market expects the VIX to move down, then the S&P 500 is anticipated to move higher. For those traders trying to determine where the overall stock market is going, checking out the shape of the curve may be a good tool to add to your trading tool box

VIX Contango Curve.jpg