VIX futures are financial derivatives that allow traders to speculate on or hedge against future volatility in the stock market, specifically the S&P 500 index. They are based on the CBOE Volatility Index (VIX), which measures market expectations of near-term volatility. Unlike spot VIX, which reflects current market volatility, VIX futures reflect market expectations of volatility at different points in the future. This often leads to a term structure where VIX futures prices can be in contango or backwardation.
Reference [1] proposed a framework to price VIX futures. Essentially, the authors break down the factors affecting VIX futures term structures into two key components: demand and variance risks. They pointed out,
… shocks to the variance and demand factors alter the term structure of VIX futures differently. Assessing the implications of the shocks is useful for exploring risk management strategies based on VIX futures. For instance, a positive shock to the variance factor increases economic uncertainty, and leads investors to expect the impact of the shock to be large but short-lived. Hence, investors tend to hold more short-term VIX futures to hedge against these volatility risks. In contrast, a positive shock to the demand factor directly reduces investor demand for VIX futures, leading futures prices to fall. When investors realize that the demand shock is sustained, they reduce their investment in long-term VIX futures and short long-term VIX futures to deal with the demand risk.
… We find that the jump risk contributes to explaining the conditional mean, variance, and higher-order moments of VIX futures. The parameters pertaining to the investors’ demand and arbitrageurs’ risk aversion are nontrivial in terms of pricing futures and fitting the term structure. We compare the variance and demand factors and find that the former is more important in pricing short-term futures, whereas the latter has a greater effect on long-term futures. In addition, the impulse response analysis suggests that shocks to the variance factor dissipate more quickly over the horizons than shocks to the demand factor.
In short, the VIX futures term structures can be influenced by these demand and variance risks.
This is an important contribution to the research on the pricing of VIX futures as it could help explain why, recently, short-dated VIX futures are in backwardation, while the spot VIX is in contango.
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References
[1] Yang X. & Huang J., Demand Risks and Term Structure of Volatility Index Futures, Journal of Management Science and Engineering, 2024
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