Don Kauman here.
Today was one of those beautiful, chaotic, gut-wrenching trading sessions that make you question everything and love it at the same time.
The Dow came roaring back after being down more than 600 points. The S&P 500 sliced through the morning like a butter knife, down nearly 2% before clawing back most of those losses.
And the Nasdaq?
Yeah, that was a rollercoaster, too.
So, what lit the fire under this market? Tariffs.
Trump’s weekend announcement slapped new tariffs on Mexico, Canada, and China, sending the market into a frenzy.
Investors panicked, pricing in an escalating trade war that could disrupt global supply chains, ignite inflation, and slow the economy. But then—just like that—a pause on Mexican tariffs was announced, and the market’s mood flipped faster than a short squeeze on Tesla.
Now, while the headlines screamed about tariffs and trade wars, what really mattered today wasn’t just the news—it was the volatility.
And I don’t just mean the S&P bouncing around like a caffeinated squirrel. I mean the kind of volatility that runs deep, the kind of volatility that shows up in volatility futures.
If you don’t know about volatility futures, buckle up.
You’re about to get a crash course in one of the most important tools for understanding market behavior. Let’s get into it.
What Are Volatility Futures?
Alright, let’s break this down. You’ve probably heard of the VIX, right? The so-called “fear gauge.” CNBC loves talking about it, and it’s the number traders point to when markets are shaking. But here’s the thing: the VIX is just a calculation. It’s not something you can trade directly.
Volatility futures, on the other hand, are the real deal. They’re tradable contracts that let you bet on—or hedge against—future levels of market volatility. If the VIX is like a thermometer for the market’s current fear, volatility futures are the weatherman predicting the next storm.
For example:
- A February volatility future reflects what traders expect volatility to look like 30 days from now.
- A March volatility future reflects expectations 60 days from now, and so on.
The further out you go, the more uncertainty gets baked in. More time means more potential for chaos—and higher volatility.
Why Do Volatility Futures Matter?
Here’s the deal: volatility futures aren’t just about tracking fear. They shape how the market moves. They’re like the hidden gears turning underneath all the price action you see on your screens.
Contango vs. Backwardation
These are fancy words that describe how volatility futures are priced. Don’t let the jargon scare you—it’s pretty simple:
- Contango (Normal Market Conditions)
- In contango, longer-dated volatility futures are priced higher than shorter-dated ones.
- Why? Because the future is uncertain, and more time means more potential for volatility.
- Example: February futures at 18, March at 19, April at 20.
Backwardation (Market Stress)
- In backwardation, shorter-dated volatility futures are priced higher than longer-dated ones.
- Why? It signals immediate fear or uncertainty in the market. Traders are saying, “The world’s blowing up NOW, but things might calm down later.”
- Example: February futures at 22, March at 20, April at 19.
Today, the market was flirting with backwardation.
If volatility futures had inverted (gone into backwardation), it would’ve been a big red flag that fear was gripping the market. Backwardation isn’t just a warning—it’s the market screaming, ‘Crap is hitting the fan!’
How Volatility Futures Shape Market Moves
Here’s where things get wild. Volatility futures don’t just reflect market sentiment—they influence it.
1. Market-Making and Hedging
Market makers and big institutions use volatility futures to hedge their positions. But when volatility spikes—like it did today—they’re forced to sell S&P futures or stocks to offset risk. This can create a feedback loop, where selling begets more selling, driving the market lower.
As I said during today’s TheoTrade Live Chatroom session:
“When volatility futures invert, market makers have to sell S&P futures to hedge their positions. That’s when the market starts punching lower.”
2. Predicting Market Behavior
If you’re watching volatility futures, you’ll often see the storm coming before it hits. When near-term futures spike higher than long-term ones, it’s a sign the market is bracing for immediate turbulence.
Today, traders saw volatility shoot up early in the session as tariff fears took hold. But as news of the pause in Mexican tariffs broke, volatility futures eased, signaling that the panic was subsiding.
What Today’s Market Taught Us About Volatility
The lesson from today is simple: volatility tells the real story. Sure, headlines about tariffs and trade wars grab attention, but the movement in volatility futures showed how fear was being priced—and how quickly it dissipated once the news improved.
Here’s what happened:
- Early Panic: Tariff announcements sent fear rippling through the market. Volatility futures spiked, and stocks fell sharply.
- Relief Rally: News of a temporary pause in Mexican tariffs calmed nerves, leading to a rapid recovery.
- Volatility Futures Reaction: As markets stabilized, near-term volatility futures fell, signaling reduced short-term fear.
If you were watching volatility futures today, you had a front-row seat to the market’s emotional rollercoaster.
How You Can Use Volatility Futures
Now that you’ve got the basics, let’s talk about how you can use volatility futures in your trading.
1. Gauge Market Sentiment
- Contango = calm markets.
- Backwardation = fear is here.
If volatility futures are moving into backwardation, it’s time to get cautious.
2. Plan for Volatility
If volatility futures are spiking, expect bigger swings in the market. Tighten your stop-losses, lower your position sizes, and don’t get caught off guard.
3. Don’t Rely on the VIX Alone
The VIX gets all the attention, but it’s just a snapshot of 30-day implied volatility on the S&P 500. Volatility futures give you a more complete picture of what’s coming.
Why Volatility Matters
Volatility futures aren’t just numbers on a screen—they’re the heartbeat of the market. They influence how institutions hedge, how fear gets priced, and how markets move.
today’s market action was a perfect example. The Dow, the S&P, and the Nasdaq all saw wild swings driven by fear, relief, and everything in between. But if you were watching volatility futures, you had a better sense of where things were headed.
As I said in today’s TheoTrade Live Chatroom:
“Let the positions come to you. This is volatility. This is what we wait for.”
So, the next time the market starts swinging, don’t just stare at the headlines. Watch the volatility futures—they’re the real story.
To your success,
Don Kaufman
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