Quantifying VIX Contango and Backwardation

I’m in the process of updating different VIX related charts and statistics for next week’s three day VIX webcast series. I realized it has been a while since I addressed the topic of VIX contango and backwardation.   For those unfamiliar with these terms, a picture is worth a thousand words. The term structure illustration below shows a textbook example of what contango and backwardation are all about.

Contango Fixed

Typically a term structure chart created using VIX futures looks more like the blue contango line above where the futures prices are higher as there are more days left to expiration.  In times of increased VIX the term structure takes on the form that looks a bit more like backwardation where the futures prices are lower than the spot index. The financial engineer in me went to work and I came up with a method of quantifying the shape.

To calculate my method of determining whether the market is in contango or backwardation I take the next two VIX futures contracts that have at least one weekend left until expiration. The Friday before VIX futures and options expire is the day where I roll into the next pair of futures contracts. For example last Friday August 15th the pair changed from August and September VIX to September and October VIX.   I use the pricing of these two relevant futures contracts and time weight them based on days to expiration. The time weighted result is a consistent VIX future that may be used to compare the futures market to spot VIX. A chart covering January 2, 2014 through August 15, 2014 of this modified VIX future price relative to VIX appears below.

VIX vs Mod VIX

Note more often than not the VIX future is at a premium relative to VIX. Also when VIX moves up quickly the index will sometimes close at a premium relative to the modified VIX future. When VIX is higher than the modified future I define the market as being in backwardation. When the index is at a discount to the modified future I say the market is in contango. The table below shows how often the VIX term structure has been in contango or backwardation from January 2007 through last Friday. I also put the S&P 500 price performance for each year at the end of the table.

Contango Table

Since 2007 on about 20% of trading days the modified future is at a discount to VIX. The majority of these days occurred in 2008 when the stock market was under pressure.   Also note over the most recent time period we have not seen too many backwardation days – this goes along with relative calm and bullishness in the overall market.

If you have more interest in the modified VIX future versus the index I will spend more time discussing it next week during the three day noon webcast series that is going to run from Monday through Wednesday next week. To register click on www.cboe.com/webcasts


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Russell Rhoads, CFA

CBOE Options Institute

Russell Rhoads, CFA, is a Senior Instructor with the Options Institute at the Chicago Board Options Exchange. He joined the Institute in 2008 after a career as an investment analyst and trader with a variety of firms including Highland Capital Management, Caldwell & Orkin Investment Counsel, TradeLink Securities and…