Book 3 - Exhibit 2 shows a bunch of VIX futures contracts (one stable, one contango – Day 120, one backwardization – Day 60).
On page 321, it says in the text that if the basis declines linearly until settlement when the term structure is in contango the trader who is long in the back month VIX futures contract realizes losses.
If you’re short the back-month, you will profit.
I just don’t understand what this means. Can somebody explain in basic terms. Reason I ask is, EOC 7 asks this question but I don’t understand.
Go look at your etrade account for VIX options and this might help you. Also, understand that VIX futures are what’s used to price the value of each months options. www.vixcentral.com will give you what the current term structure is for vix - maybe looking at actual vix futures will help you understand this.
If vix futures are in contango you would sell vix calls because it’s assumed those futures prices will roll down to the spot price - which is below the future price.
If vix is in backwardation you would buy vix calls because it’s assumed those futures prices will roll up to the spot price.
I think that the VIX example in the curriculum leaves a lot to be desired, and I have communicated such with CFA Institute.
With luck, they’ll provide additional text that will help explain the example further.