A Historical Look at VIX Contango

I got a couple of great questions from a really smart guy via twitter this weekend. Alex Bernal (@interestratearb) of Aether Analytics www.aetheranalytics.com asked about the amount of time VIX futures have been in contango or backwardation and then followed up with asking what is the longest period VIX futures have been in contango?

 

First a quick note for those unfamiliar with the terms contango and backwardation. Both are terms used to describe the price action of futures contract prices relative to each other and their underlying market. Contango refers to prices being at a premium to the underlying market and each other as prices move out in the future. Backwardation refers to prices being at a discount to the underlying market and each other as expiration moves out. The majority of trading days, VIX futures trade at a premium to VIX and are in contango. When VIX rises quickly in price, the index will often move to a premium relative to the futures and the pricing will move to backwardation.

I have a way of determining whether VIX trading is in contango or backwardation that involves modifying the front two month VIX futures and comparing that outcome to the spot VIX index. It involves a time weighting of these two futures so that as expiration approaches for the near month the second month contributes more to the calculation. On the Friday before expiration I ‘roll’ my formula to make the second month the front month and then start using the third month as the second month. For example, November 16th was the Friday before November expiration. On that date I started using December and January futures pricing for what I call the Modified VIX Futures price. This modified price is for analysis only and definitely not something that can be traded. 

Using that formula and data going back to the first day of 2007 through the November 16th roll date created the table below –

 

 

Trading Days

 

Contango

 

Backwardation

 

% Contango

 

% Backwardation

2007

251

177

74

70.52%

29.48%

2008

253

143

110

56.52%

43.48%

2009

252

202

50

80.16%

19.84%

2010

252

223

29

88.49%

11.51%

2011

252

178

74

70.63%

29.37%

2012

221

221

0

100.00%

0.00%

Total

1481

1144

337

77.25%

22.75%

 

The numbers speak for themselves, but note 2008 where the market was in backwardation more than any other year. This was due to the high level of market volatility (realized and VIX) that was experienced that year. Also note this year, 100% of days (by my definition) the market has been in contango. Others have noted differently, but we all have our own way of trying to quantify it. 

Finally, the other question – back in 2008 from September 12th to December 11th – VIX futures were in backwardation for 64 trading days. For those of you that have blocked this period out of your mind, a quick reminder, the S&P 500 was actually down 30% over that three month period. As I said before, VIX futures are typically in backwardation during periods of high market volatility. I think all agree a 30% drop in 64 trading days can be defined as high volatility.