Time Frame: Medium-Term | Update Schedule: Daily | Source: CBOE
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Sometimes you might hear that the VIX futures went into backwardation.
For those who aren't familiar with that indicator, or with futures terminology, that sounds like gobbledygook.
In reality, it's pretty straightforward. The VIX is used as a "fear gauge" which measures traders' estimates for how volatile stocks will be over the next 30 days. Sometimes, futures contracts based on that indicator will drop below the spot price, suggesting that traders think volatility will fall soon.
It's rare to see futures contracts that don't expire for awhile to be lower-priced than the near-term futures.
For this indicator, we're comparing the 1-month VIX futures to the 3-month VIX futures (where futures traders think the VIX will be priced in 3 months), a way of looking at what is call "term structure".
The spread will be high if futures traders think volatility is going to spike in the near-term. Usually this occurs during times of panic.
When futures traders are pricing in much higher volatility levels (i.e. the blue indicator goes above the green dotted line), then it means that traders are panicking and pricing in high amounts of near-term volatility. It usually doesn't pan out that way - stocks most often bottom soon after the ratio reaches 1.0, or 1.2 in times of true duress.
When futures traders are pricing in lower near-term volatility (i.e. the blue indicator goes below the lower red dotted line), then it's a sign of complacency and stocks often have trouble rewarding that going forward.
