Is the return on CBOE S&P 500 Volatility Index (VIX) futures predictable? In his preliminary paper entitled “The Expected Return of Fear”, Ing-Haw Cheng investigates whether the relationship between VIX futures prices and VIX level predicts the return on VIX futures. He focuses on monthly returns to a continuously-invested position in the nearest available VIX futures contract. He considers several different explanations for the behavior of VIX futures prices. Using VIX futures daily settlement prices during March 2004 through July 2014 (125 months), *he finds that:*

- The average level of VIX over the sample period is 19.9%, compared to 16.2% for the annualized realized volatility of the S&P 500 Index over the next 30 days. The average annualized volatility of VIX (VVIX) is 84% over this period.
- On average over the sample period, VIX futures prices are higher than VIX and exhibit muted reaction to changes in VIX (1% increase in VIX relates to 0.65% increase in the nearest futures contract price).
- Over the sample period, a continuous long position in the nearest VIX futures contract:
- Has an average maturity 34 days.
- Exhibits a market beta of about -3.
- Generates a gross monthly excess (relative to the risk-free rate) return of -4% with monthly volatility 16.7% and gross monthly Sharpe ratio -0.23.
- Generates, however, a non-negative gross average return over the month after instances of backwardation (peaks of crises, when VIX exceeds VIX futures prices).

- The ratio of VIX futures price to VIX level relates negatively to next-month VIX futures return with an R-squared statistic of 0.16, indicating that the ratio explains 16% of the variation in return.
- A simple trading strategy which each month sells nearest-term VIX futures (holds cash) when the ratio of VIX futures price to VIX level is greater than one (not greater than one) generates a gross average monthly excess return of 4.3% with monthly volatility 11.9% and gross monthly Sharpe ratio 0.36.
- The relationship between VIX futures price and VIX level does not predict U.S. stock market returns.

In summary, *evidence indicates that investors may be able to time a short position in VIX futures according to the ratio of VIX futures price to VIX level, exiting when the ratio is less than or equal to one.*

Cautions regarding findings include:

- Reported performance is gross, not net. Accounting for trading frictions from entering and exiting contracts approximately monthly would reduce returns.
- Exiting short positions during crises may incur exceptionally high frictions.
- The high volatility of the timing strategy suggests large drawdowns.
- Return on investment calculations would have to account for cash reserves required for any margin calls that may occur during intra-month drawdowns.

For implementations of this timing strategy with exchange-traded notes (ETN), see “Exploiting VIX Futures Roll Return with ETNs” and the Roll Yield trading strategy in “Volatility Trading Strategies”.