Schaeffer's Trading Floor Blog

A Study in Volatility Hindsight

Reviewing the aftermath of the Jan. 24 volatility pop

by 2/17/2014 8:28 PM
Stocks quoted in this article:

Can we now officially put the Jan. 24 volatility pop in the history books? I will say yes. I'm not saying we won't see another pop soon, just that if in fact we do see a pop, it's essentially a new "event." Enough time and price action has passed that we can better analyze this past one.

The SPDR S&P 500 ETF Trust (NYSEARCA:SPY) closed at $184.02 on Friday, almost exactly unchanged on the year. When the CBOE Volatility Index (VIX) flipped to overbought on Jan. 24, the SPY closed at $178.89, so we're up 2.87% since. Yes, you've won if you bought then and held, but it was a trade that looked a bit worse before it got better.

VIX closed at 18.14 that day, but it didn't actually peak until it went out at 21.44 on Feb. 3. The SPY closed at $174.17 that day, so if you had the prescience to buy there, you've realized a 5.65% gain. Thus, I think it's fair to say that while the overbought VIX signal was good in that it worked, it wasn't terrific as there was a way better entry point six trading days later.

How about our good friend the iPath S&P 500 VIX Short-Term Futures ETN (VXX)? If you shorted it when VIX got overbought, you had a rough start to the trade as well. After a week, VXX had rallied 10.79%. But alas, all good things must end, especially when the words "VXX" and "rally" are used together. Three weeks post-pop, VXX is returning to be the dog we love so much. It's down 6.13% from Jan. 24.

Here's an updated version of a table I ran a few weeks ago on VXX performance after VIX pops.

Table of VXX performance after VIX pops

At the bottom, I show how you would have done going long VXX on random dates as a comparison. It's the seventh straight time that shorting VXX after a VIX pop and holding for three weeks would have worked. This was the weakest win of the seven, though, and if you have a three-week (or longer) window, you actually do better if you randomly short VXX as opposed to specifically timing a VXX short in this manner.

But (and it's a big but) that "timed" VIX short is very influenced by a disastrous trade initiated on July 29, 2011. VXX rallied a further 81%. You would have won shorting VXX in 10 of the 14 instances, but that gigantic loss and a 41% "Flash Crash" hit on May 4, 2010 make the net results look relatively poor. Remember, VXX tends to drift most of the time anyway.

Just an aside, but VXX has now gone 17 trading days since last hitting a new all-time low. It's getting close, though, and the number to watch is $39.85. It's the longest streak since last fall, as VXX went from Sept. 19 to Oct. 17 without making any history (20 trading days!). If VXX can keep the un-horrible times rolling though this week, it will mark the longest run since well, last August into September (31 trading days!).

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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