A volatility trader observes that the VIX term structure is upward sloping. In particular, the VIX is at 13.50, the front- month futures contract trades at 14.10, and the second- month futures contract trades at 15.40. Assuming the shape of the VIX term structure will remain constant over the next three- month period, the trader decides to implement a trade that would profit from the VIX carryroll down. She will most likely purchase the:
The answer is:
C VIX front- month futures and sell the VIX second- month futures.
Can someone please explain how the answer works in terms of how exactly we profit from roll yield?
Assuming that the term structure is unchanged in one month, what will be the price on the (now) front-month VIX future and the (now) second-month VIX future?
The front month will be the spot price and the second month futures will become the front month futures with a price of 14.10. But since we are buying the front month futures and selling the second month when the curve is in contango, won’t the front month futures have negative roll since we went long and second month futures have positive roll since we went short? How can I know from the question that we will have net positive roll yield? Thanks for your help!
If the curve is unchanged… You are right. You are in the trajectory and the same will yield as promised one month back.
Secondly, declutter with the jargons of contango and backwardstion. Since the trajectory is unchanged just think you are trading on thebfwd. Curve. You buy low and sell high for a positive roll yield.
Front month VIX loss would be 0.60 and the second month gain would be 1.30 for a net gain of 0.70.
but I don’t understand why we didn’t just take the winning position i.e. just short the second month futures. What is the purpose of buying near and selling far? Why not just sell far for the gain?
I’m with you; simply selling (i.e., taking the short position in) one of the futures would be sufficient, but that wasn’t one of their answer choices. Oh, well.
It sounds as though the point of the question was to stress that you cannot buy or sell the VIX itself; you can buy or sell only futures (or options) on the VIX.
