This article was prepared in connection with the launch of Mini Cboe Volatility Index (Mini VIXTM) futures on Cboe Futures Exchange, LLC (CFE). Before you trade Mini VIX futures, it's important to understand the following:
- Mini VIX futures are complicated financial products that are suitable only for sophisticated market participants.
- Mini VIX futures involve the risk of loss, which can be substantial and can exceed the amount of money deposited for the futures position.
- Market participants should put at risk only funds that they can afford to lose without affecting their lifestyles.
- Before transacting in Mini VIX futures, market participants should fully inform themselves about the characteristics and risks of Mini VIX futures, including in particular those described below. Mini VIX futures market participants also should make sure they understand the product specifications and the methodologies for calculating the underlying VIX® Index and the settlement values for Mini VIX futures.
Groundbreaking products, like VIX futures and options, often have unique characteristics that appeal to market participants. In many ways, volatility exposure has become a new asset class. Volatility, by definition, is directionally agnostic with upper and lower bounds, as well as having other traits that may allow for unique investing strategies and opportunities.
INVERSE RELATIONSHIP WITH S&P 500
Generally, the VIX Index tends to have an inverse relationship with the S&P 500 Index. This negative correlation has earned the VIX Index the "fear gauge" moniker because VIX Index has a tendency to move up quickly when the broad market declines with velocity.
Expected volatility typically increases when markets are turbulent, or the economy is faltering. In contrast, if
stock prices are rising the VIX Index tends to fall or remain steady at the low end of the scale. Source: Cboe
The inverse correlation of the VIX Index makes the tradeable futures and options contracts potentially attractive risk management or hedging vehicles. The negative correlation tends to improve (become more negative) during periods of meaningful macro duress (e.g. 2008 and 2020).
As a forward-looking indicator, the VIX Index also tends to be mean reverting; over time it will generally return or move back to its historical average. Volatility cannot move higher in perpetuity. It also cannot move to zero, which is distinct from equities. Volatility is a constant. It oscillates in a wide range around a mean (which changes over time). This inherent dynamic does not lend itself to buy-and-hold strategies.
The relationship between contract prices of different expiries is known as the product's term structure. It can be described by its shape as being in contango (near term is priced lower than longer term) or backwardation (near team is priced higher than longer term). Since 2007, the VIX futures term structure has been in contango (front month future at a discount to second month future) during approximately 80% of the daily observations1, including those on February 19, 2020. However, when market expectations for near-term volatility rise, the term structure can shift into backwardation as it did during the market decline in March 2020.
1. CFA Institute, 2020, "The VIX Index and Volatility-Based Global Indexes and Trading Instruments"