Vance Harwood | Aug 14, 2012 03:17AM ET
Normally you can invest in mid-term volatility, four to seven months out, without worrying too much about the erosive effects of CBOE’s VIX term structure chart below reveals that this steep term structure is also present in the VIX Index.
Since the VIX index just reflects implied volatility on SPX options, the shift in term structures must be present in SPX options also.
Since the SPX option market is considerably bigger than the VIX futures market I assume that the VIX futures are just tagging along—for reference the notional value of the 4th through 7th months of VIX futures is currently around $2.5 billion.
Historically mid-term volatility futures are in contango 75% of the time; a sustained increase in average contango from less than 2% per month up into the 3% to 4% range will unhinge a lot of hedging strategies. Not many schemes can survive that much extra loss.
If you are long medium-term volatility directly, or via an ETP you should re-evaluate.
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