The Relationship Between VIX Futures, VIX ETFs, and the VIX
Understanding the complex dynamics between VIX futures, VIX ETFs, and the VIX itself is crucial for traders and investors. This article delves into the intricate interplay between these financial instruments, providing insights based on the latest market data and academic research.
What is the VIX?
The VIX, often referred to as the fear gauge or volatility index, measures the expected future volatility of the SP 500 Index. It is a widely used indicator that reflects investors' expectations for near-term stock market volatility. Unlike other financial instruments, the VIX is calculated from hard options data and is not directly tradable. It serves as the underlying index for several ETFs and futures contracts.
VIX Futures and VIX Options
VIX futures and VIX options are tradable financial instruments that allow investors to speculate on and hedge against future volatility. The VIX futures are entirely independent of the VIX itself. While the underlying basis of VIX futures is the implied volatility (IV) of SPX options, the VIX is based on the prices of VIX futures. This means that VIX futures prices directly impact the VIX, as VIX options are priced entirely based on the VIX futures price.
The relationship between VIX futures and VIX ETFs is a bit different. VIX ETFs are not directly linked to VIX futures; they are distinct financial products that track the VIX. These ETFs can still have an indirect influence on the VIX through trading activities, but they do not drive the VIX directly.
Indirect Effects: How VIX Futures and ETFs Influence the VIX
While VIX futures and ETFs do not directly drive the VIX, they can have an indirect impact through market psychology. Traders who believe that volatility will rise may increase their demand for VIX futures, leading to an upward movement in the futures price. This change in futures pricing can affect the implied volatility in SPX options, thereby impacting the VIX. Similarly, traders who anticipate a rise in the price of oil may respond by adjusting their futures prices, which can, in turn, influence spot prices.
However, these indirect effects are generally considered minor and may sometimes move in unexpected directions. The VIX is primarily determined by the implied volatility of the SPX options, and while futures prices can reflect the market's expectation of future volatility, they do not have a direct mathematical connection to the spot price.
Contango and the VIX Futures Market
One notable trend observed in the VIX futures market is the tendency for futures contracts to trade at a higher price than the spot value of the index. This phenomenon is known as contango. The VIX futures almost always trade in contango, which is one of the most consistent trends observed in the market.
While the VIX itself is calculated from the SPX options' implied volatility, the behavior of VIX futures has a unique pattern. This contango phenomenon suggests that there is an ongoing demand for longer-term volatility protection, which can drive the futures prices higher over time.
Conclusion
In conclusion, while VIX futures and ETFs can have indirect effects on the VIX through influencing market psychology and expectations, they do not directly drive the VIX. The VIX is primarily determined by the implied volatility of the SPX options, and the contango in VIX futures reflects the strong demand for longer-term volatility protection.