Capitulation in Back Month VIX Futures

On Wednesday, in VIX Sets Two New Records, I suggested that it was coming, but I never expected it to happen in such dramatic fashion.

In what I believe is an unprecedented move, the VIX futures collapsed today without any movement in the front month VIX futures.

For those who are fixated on the cash VIX and the first two months of VIX futures, the movement in the November through May VIX futures chronicled below probably looks unremarkable, as proportional as it is, but that is exactly the point: the VIX term structure almost never moves in uniform proportions. Typically the front month moves the most, the second month may move half as month as the front month, the third month half as much as the second month and so on. See the links at the bottom for some examples.

Today the cash VIX gained 0.14 points (to close at 19.07) and the front month VIX futures held steady at 20.65, indicating that market participants see the likely October settlement for the VIX one week from tomorrow at about 1.58 points above the current level.

The really interesting part is that at the same time the consensus of opinion is calling for a short-term rise in the VIX, there was an almost audible sigh of, “Oops, we have this one wrong…” when it comes to the longer-term outlook for the VIX.

Yesterday I thought I was going out on a limb when I repeated what has been a consistent position for the last few months:

“I do believe that when estimates of near-term and long-term volatility show a record degree of divergence, some considerable opportunities are presented. As I have spelled out in a number of instances lately, my thinking has been that the back month volatility will likely collapse in order to bring the present and the future back into line. There has been some evidence of that happening during the past two days, but I anticipate that long-term volatility expectations will continue to decline.”

Today it looks as if I picked up quite a few converts. Now the question becomes one of how low the distant month volatility in the VIX futures will fall. Back in April it went as low as the 23s. Today the distant month VIX futures dipped below the 30 level for the first time since June. The May 2011 futures are already down 2.85 points (8.7%) this month and if they are to match April’s levels, there are still another 6 points left to fall.

When back month VIX futures move more than front month futures, I pay attention. Perhaps I should have more company. (Click to enlarge)