In order to expand on yesterday’s trade idea with the steepness of the VIX futures curve, we need to see just how historically steep the curve is. Today, the March 2011 VIX futures closed at 31.65 while the October 2010 contract closed at 24.95. That is a gap of 6.7 vol points! As with all trading ideas, the spread is only relative to historical levels:
The historic period back to the beginning of 2008 is highly skewed by the large vol spike at the front end of the curve during the financial crisis. Regardless of this fact, it is clear to see that the current gap of nearly 7 vol points is historically high and this shows through even better in a wider time range:
The entire history shows an average spread of .61%, but if you exclude the 2008 deviation we could rationalize an average in the 1.5-2 range with normal peaks in the 4-5 vol point range. A spread of 6.7 stands out like a sore thumb.
The less risky trade is to buy the October, sell the March and roll the long short-dated position in the VIX futures until the spread compresses. From a historical standpoint, the front part of the curve does not seem very out of whack. The more agressive trade is to make a call directionally on long-term or short-term volatility. With March 2011 VIX futures 27.5 strike calls trading at $6.4, I see this is a good short if you can handle the mark to market volatility. There are many different trades to express the view that the spread across the curve will compress, so let your creativity blend with your risk tolerance and return objectives.