It is fortunate that I wrote my previous article about stagnant volatility the day before a strong ISM number came out which created a robust equity rally and a precipitous decline in implied volatility. The VIX has decline nearly 15% this week. VIX futures have fallen rapidly across the curve, but if this rally can be sustaining it seems that the futures have a long way to fall:
The gap between the VIX Index and the 2nd month of VIX futures is at 6.86%, which is just off the absolute 6 year high of 7.46% established on August 6th. This gap cannot persist forever:
If the equity markets are able to hold onto their ground, then this looks like a great time to bet on a decline in VIX futures by shorting the October and months further out on the curve (over 32% for Jan 2011?!). If instead we believe that September and October are going to be rotten months, then it would be wise to make a pairs trade through a delta hedged long option straddle in the S&P 500 along with a short position in the VIX futures.