'Fear Index' Futures Darken Stocks' Picture

By BRENDAN CONWAY

NEW YORK—Investors who follow the market's VIX "fear index" for a reading on anxiety in stocks see a picture that is surprisingly placid. But options veterans also look to futures on the same index for a longer view, and here the prediction is for rockier trading.

The Chicago Board Options Exchange's volatility index, or VIX, tracks prices that investors are willing to pay for options on the S&P 500-stock index. The VIX managed to add just 4.4% on Friday even though the S&P 500 plunged nearly 3%. The index tends to move in the opposite direction of stocks, and on several frenzied days in May and June, it staged double-digit percentage gains.

Its failure to budge despite Friday's sizable drop in stocks suggests investors are expecting smaller swoons in the near term, at least compared with a month or two ago. The index lost 0.28, or 1.1%, to 25.97 on Monday.

But investors who look to futures discover a different picture. July VIX futures expire Wednesday, and these contracts traded at 26.80 on Monday.

This level is nearly a point above the VIX itself, even though there is very little time remaining on the contracts.

Suggestions of worry build as one looks forward. The curve of longer-dated contracts rises to around the 33 level for this fall's contracts before flattening into next year. Those levels aren't so different from much of June's harried trading, when the index nine times closed above 30. It had previously surged to the mid-40s amid May's stock market "flash crash."

"The market's expecting volatility to get back where it was toward the end of June," Randy Frederick, director of trading and derivatives at Charles Schwab, said. "People who are putting money on the line to trade futures are not expecting a selloff as sharp as late May, but they are expecting one more like late June." 

The key point to remember is that VIX futures register expectations for future periods of volatility, whereas the VIX is a read on sentiment for the near term.

"It's sort of a fulcrum," OptionsHouse Chief Investment Strategist Steve Claussen said. "When the market is volatile in the moment, the short-term VIX will likely be higher than the futures' values. Right now, we're seeing a calm market, but also a view for uncertainty to the end of the year."

Among Monday's notable options trades, one investor showed up with what appeared to be a vote for less volatility in a position tied to VIX futures.

The trader appeared to sell several thousand near-term August puts on an exchange-traded note that gives exposure to a daily rolling long position in the first and second months' VIX futures contracts, according to Option Monster. The ETN is called the iPath S&P 500 VIX Short-Term Futures Exchange Traded Note, or VXX.

Notable trades crossed the tape at the 22 and 25 levels. A trader carrying out a sale of the latter contracts at closing prices would pay $1.25 each and would make money if the VXX falls under 23.75. It shed 0.54, or 2%, to 26.83 on Monday.

A put in this instance signals expectations that the market will be calmer. Thus, this investor may have an outlook that is more like the VIX than the index's stormier futures.


Write to Brendan Conway at brendan.conway@dowjones.com