Friday provided our first glimpse into how the economy was faring in January and the stock market apparently didn’t like what it saw. VIX finished the day up 7% which was just under half the over 15% rise we got last week. The February future managed an 11% gain to finish higher than spot VIX. However, backwardation is still in place with the February contract higher than the March contract. More on this after the chart and table below.
I’ve been obsessively fixated on the current state of front month versus second month backwardation. The front month VIX future has closed higher than the second month every day in 2016. That’s a running streak of twenty four trading days. This is the longest stretch since 2011 and the fifth longest on record.
What surprised me a bit was that the spread between February and March widened on Friday. I conducted a twitter poll last Monday and the (very unscientific) result was about 2/3rds of voters thinking February would close at a discount to March regardless of how the market took the employment number. Congrats to the 1/3rd that got it right and I’ll admit I was on the side of the majority who got it wrong.
The chart below shows the spread between the first month and second month each day this year. The last time the spread was greater than or equal to 1.00 was the day after the 2016 closing low for the S&P 500. To save you the trouble of looking it up, the closing low for this year (so far) was January 20th at 1859.
On Thursday most traders were looking only one day in to the future with Non-Farm Payrolls being reported the next day. However, one of the larger VIX option trades targeted the VIX Weeklys expiration on March 9th just after the March employment number is reported. A VIX Mar 9th Iron Broken Wing Butterfly was constructed with the VIX Mar 9th 23 Puts being sold for 2.84 and VIX Mar 9th 23 Calls sold at 2.52. The trade was completed with the VIX Mar 9th 18 Puts being purchased at 0.42 and VIX Mar 9th 25 Calls at 2.01 and net credit of 2.93. The payout upon March 9th Weeklys VIX settlement appears below.
Note that a volatility event pushing VIX into the upper 20’s, or even low 30’s results in 0.93 profit. The risk is on the downside with a maximum loss of 2.07 being taken if VIX is below 18.00 at expiration (as of Thursday the closing low for VIX in 2016 was 19.34). I think the takeaway may be as long at VIX is still in the 20’s this trade will turn out OK.