The VIX term structure (or "VIX futures curve") is the relationship between the prices of short-term and long-term VIX futures contracts.
The shape of the VIX futures prices when plotted (upwards, downwards, or flat) indicates whether the market is expecting more or less market volatility in shorter-term or longer-term periods.
Additionally, the shape of the VIX futures curve has implications for the performance of volatility-related products.
The shape of the VIX term structure will fall into one of two categories:
Contango (Upward Sloping): Longer-term VIX futures contracts are more expensive than shorter-term contracts. Contango tends to occur in quiet market periods and is also the most common shape of the VIX futures curve. Check figure 1 from Vixcentral.com
Backwardation (Downward Sloping): Longer-term VIX futures contracts are less expensive than shorter-term contracts. Backwardation tends to occur during periods of extreme market volatility. Check Figure 2. from Vixcentral.com
To understand each of these curves, let's look at an example of each scenario.
The following chart demonstrates what an upward-sloping (contango) VIX term structure looks like:
On this example, the VIX Index was circa 13 while the VIX future (approximately 120 days away from settlement) is higher at about 17. The upward sloping nature of the curve suggests that market participants believe volatility will increase from 13 in the future, which makes sense because the long-term average VIX level is around 20.
In the event that the VIX Index (prices of S&P 500 options) remains around 13, the price of each of these VIX futures contracts will lose value as time passes.
Consequently, any long VIX futures traders will lose money, as well as traders who have on bullish trades in related volatility products (bullish VIX option trades, VXX and UVXY). On the other hand, traders with short VIX futures contracts or bearish positions in volatility products will are likely to profit (bearish VIX option trades or SVXY).
The following chart demonstrates what a downward-sloping (backwardated) VIX term structure looks like:In this case, the VIX Index is around 70. However, the VIX futures contract (about 150 days until settlement) is about 30 points lower at 36. The downward-sloping nature of the curve suggests that market participants believe volatility will decrease from 70 in the future, which makes sense because the long-term average VIX level is around 20.
In the event that the VIX Index (prices of S&P 500 options) remains around 70, the price of each of these VIX futures contracts will "slide up the curve" as time passes. Consequently, any short VIX futures traders will lose money, as well as traders who have on bearish trades in related volatility products (VIX options, VXX, UVXY, etc.). However, any traders who are long VIX futures or have bullish positions in volatility products are likely to make money.
