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description, tags
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| VIX futures basis trading is a mean-reversion strategy that shorts VIX futures when the basis is positive (contango) and buys when the basis is negative (backwardation), based on the empirical finding that the basis predicts subsequent VIX futures price changes. |
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VIX Futures Basis Trading
Section: 7.2 | Asset Class: Volatility | Type: Mean-Reversion
Overview
The VIX futures basis is the difference between the first-month VIX futures price and the VIX spot price. Empirically, the basis has no forecasting power for subsequent VIX changes, but does forecast VIX futures price changes (mean-reversion). When the curve is in contango (positive basis), futures prices tend to fall; when in backwardation (negative basis), futures prices tend to rise. The strategy trades this mean-reversion.
Construction / Mechanics
VIX futures basis:
B_VIX = P_UX1 - P_VIX (429)
Daily roll value (normalized by days to settlement T):
D = B_VIX / T (430)
where:
- P_UX1: price of the first-month (UX1) VIX futures contract
- P_VIX: VIX spot price
- T: number of business days until settlement (assumed ≥ 10)
- D: daily roll value (basis per business day remaining)
Trading rule (based on D):
Rule = { Open long UX1 position if D < -0.10
{ Close long UX1 position if D > -0.05
{ Open short UX1 position if D > 0.10
{ Close short UX1 position if D < 0.05 (431)
- Short UX1: when the curve is in contango (D > 0.10); futures price tends to converge down toward VIX.
- Long UX1: when the curve is in backwardation (D < -0.10); futures price tends to converge up toward VIX.
Optional hedge: short UX1 position can be hedged by shorting mini-S&P 500 futures (since VIX and equity markets are anti-correlated; a VIX spike usually accompanies an equity selloff).
Payoff / Return Profile
- Profits when VIX futures prices revert toward the VIX spot (as they do at settlement).
- In contango: short position earns the roll-down as futures price falls toward VIX.
- In backwardation: long position earns the roll-up as futures price rises toward VIX.
- Loses when VIX spikes suddenly (short position) or crashes (long position) before mean-reversion occurs.
Key Parameters / Signals
- D = B_VIX / T: the daily roll value — primary signal
- Entry thresholds: |D| > 0.10 to open; |D| < 0.05 to close
- T: days to settlement (must be ≥ 10 for the strategy to be viable)
- Hedge ratio: estimated from serial regression of VIX futures price changes on mini-S&P 500 futures returns
Variations
- Use a basket of VIX futures (UX1, UX2, etc.) rather than just UX1 for more stable exposure.
- Combine with VIX ETN strategies (VXX/VXZ carry, Section 7.3).
Notes
- A short UX1 position is exposed to the risk of a sudden VIX spike (equity market selloff), which typically requires the mini-S&P hedge.
- The hedge ratio for the mini-S&P position should be estimated from historical regression of VIX futures price changes on S&P 500 futures returns.
- The empirical basis for this strategy rests on the mean-reverting property of the VIX futures basis, documented in Mixon (2007), Nossman & Wilhelmsson (2009), Simon & Campasano (2014).
- Settlement date proximity (small T) makes D volatile and the signal unreliable; hence the T ≥ 10 minimum requirement.