About a year ago, we were all starting to focus on the Brexit referendum which we ‘knew’ wasn’t going to pass. There were several lessons from the Brexit experience with the top one being do not discount an election until all the votes are counted. This played out again in November, but that’s not what this blog is about. This blog is about how VSTOXX and VIX are behaving in front of the pending French election process.
First, going back to June 2016 I decided to look at the behavior of VIX, VSTOXX, and associated futures contracts leading up to the surprise Brexit outcome. For those not familiar with VSTOXX it is the European equivalent of VIX but based on the implied volatility of options listed on the EuroStoxx 50 index. There are also VSTOXX futures available for trading which give us an extra method of looking at European volatility.
In 2016, the July VSTOXX futures were the first contracts to expire after the late June Brexit vote. As the day of the vote got closer the July contracts worked their way higher and the July VIX futures followed suit. After the results and a spike in volatility both VIX and VSTOXX futures trended lower into July settlement (see below).
The spot VIX and VSTOXX indexes behaved in a similar fashion with VSTOXX hitting highs just before the Brexit outcome and VIX spiking after. Volatility futures prices are based partially on the anticipation of where the spot volatility index will be in the future and the July contract appeared to lead the spot indexes higher and lower last summer.
Leading up to French election the April VSTOXX futures have been trading in the low to mid 20’s for some time. Last month, VSTOXX tumbled the day after the Dutch general election which barely influenced the futures pricing. Notice on the chart below that over the past few days the spot index has started to gravitate toward the April contract price. As the first round of the election draws near this pattern may continue. What also occurs before the election is the expiration of the April VSTOXX futures contracts. So why are the futures elevated and ignoring spot VSTOXX price action?
It may just be that the April contract is discounting elevated implied volatility before the election. Much like the implied volatility increases for options on individual stocks just before an earnings announcement. The VSTOXX market is also telling us another story, that after the election is done the implied volatility of EuroStoxx 50 options will drop off. How do we know that? The May futures contracts which settle after both rounds of the French election are trading much lower than the April futures. The term structure chart below is based on the April 3rd closing prices for VSTOXX and associated futures.
Notice the spike in the April pricing and return to normalcy for the rest of the curve. That’s what the VSTOXX curve is telling us with respect to the election and that reaction would be very similar to what we got from Brexit, volatility quickly move up and then quickly settling down.
The big question on this side of the Atlantic ocean is if VIX will start to take notice of what’s going on in Europe or will VIX remain at low levels. For now, the VIX futures markets are on the fence. I say that because April and May futures are basically priced in line with each other as shown in yesterday’s closing VIX term structure.
Watching the April to May VIX futures relationship may be more important than spot VIX for an indication of volatility will elevate before the French take to the polls. We will keep watching the news and subsequent reactions from the volatility markets in Europe and the US and report all interesting developments here.