Volatility Term Structures Now Reflecting Lower Election Risk

Weekend Review For Week Of September 9, 2024 - September 13, 2024

Over the past few months, VIX and VSTOXX traders have been fixated on the relationship between the October and November futures. The specific situation was the October contract at a consistent premium to the November contract in both markets. This cause of this is how both VIX and VSTOXX futures are settled, using pricing from SPX and Euro Stoxx 50 option contracts that expire 30 days after the respective volatility indices’ settlement date. This means that the October contracts for both VIX and VSTOXX, which expire on October 16, will use index pricing from the November 15 contracts in each underlying market.

The US election is Tuesday November 5, so the October volatility futures expire before this event, but if the market is concerned about the outcome, the aftermath, the validity (pick your choice) of the election they would be using November options to manage this risk. That is the brief explanation about why the October VIX and VSTOXX contracts have been trading at a premium to the November future. That is until this past week.

The previous chart is a daily depiction of the spread between the October and November VIX and VSTOXX contracts. Note the relationship hovered in the 1-to-2-point range in April and May, then started to trend lower until the price action in early August pushed volatility expectations higher in a short period of time. Post those moves, the spread moved below 1 but remained positive for both markets until last week. As of the end of last week, the Oct – Nov VIX premium was 0.18, the lowest over the life of the two contracts. Even more significant is the Oct – Nov VSTOXX spread which finished Friday at -0.10, the first close with October at a discount to November.

My interpretation is that election risk, not necessarily who will win, but the risk that the election will result in uncertainty of the outcome. After this week’s debate there may be a feeling that the election outcome will be certain to a point where we may not experience any challenge related to the outcome. We will keep a close eye on the October and November VIX and VSTOXX relationship to see if uncertainty starts to creep back into the market.

The S&P 500 (SPX) was higher by over 4% last week for the best weekly return in almost a year and the Russell 2000 (RUT) was up slightly more than SPX (+4.36%). The big winner was the Nadaq-100 (NDX), gaining almost 6%.

VIX was lower by almost 6 points and the term structure almost returned to the levels from two weeks ago after rising and inverting in the first week of September. We included the previous two weekly VIX term structures on the graphic below to illustrate the quick round trip in the VIX term structure.

The short VIX ETPs benefitted quite nicely with SVIX gaining 13.71% last week while UVIX gave back 24.72% last week. A combination of lower volatility expectations and steep Month 1 versus Month 2 contango both contributed to the big changes for these products last week.

The VSTOXX term structure followed VIX’s lead so we included three curves here as well. The recent closing term structure mostly falls in line with the close on August 30. A big difference between VIX and VSTOXX is that October versus November relationship with October at a discount to November in the VSTOXX complex, but not VIX.

Straddle sellers have had a tough time lately, but last week brought a little relief. The SPX 1-day at-the-money (ATM) straddle overpriced the SPX price move only two of five days last week, but the profitable days outpaced the unprofitable ones.

NDX straddle sellers did not fare as well as SPX traders mostly due to a very strong NDX day on Wednesday.

The week started off nicely for RUT option sellers, but things turned red on Thursday and ugly on Friday.

The best index option market to sell 1-day straddles was the Euro Stoxx 50 with the straddle overpricing the move four of five days and the losing day only racking up a loss of 3.33.

Finally, the DAX price action looks more like the US markets than the Euro Stoxx 50 with two winning days outpaces the three losing days on a points basis.