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What a difference a month makes.
The CBOE Volatility Index (INDEXCBOE:VIX) closed 2013 at 13.72. It closed January at 18.41 for a nice little 34% pop. The entirety of the pop occurred in the past week or so, as the VIX closed at 13.77 as recently as Thursday, Jan. 23. So, it's really only been a week of strong VIX.
The VIX first flashed to overbought (defined as 20% above its 10-day simple moving average) on Friday, Jan. 24. The SPDR S&P 500 ETF Trust (NYSEARCA:SPY) closed at $178.89 that day. Intraday volatility has spiked up, but net-net, it's a treadmill to nowhere so far as a week later, the SPY has dipped to $178.18.
And yes, all that intraday action made it feel worse.
On Tuesday, I noted a "system" trade in the iPath S&P 500 VIX Short-Term Futures ETN (VXX), wherein you shorted it when the VIX went to overbought, and then covered one, three, or five weeks later. The one-week trade had worked seven straight times, last failing in July 2011. Well, guess what? That streak has ended. Even though the market itself has barely budged, and the VIX itself is only 4% higher, the VXX lifted 10.8% on the week.
Flight to quality? Well, I wouldn't go that far. But, there was some interesting action in VIX futures. Here's how the term structure looked on the close of Friday. (Chart courtesy of VIXCentral.com, click to enlarge.)
The front part of the curve actually has some backwardation going on. Since the VXX has to perpetually roll out in time, it actually earns small money now every day. And with VIX futures themselves at a discount to the VIX, the VXX can make some money there too, if the futures converge up to the VIX.
That latter part is unlikely, though. VIX futures always assume some sort of mean reversion. For most of the time, the mean they price in is higher than VIX itself. And for the better part of the VXX's existence, that assumption of a somewhat permanently higher VIX "tomorrow" has proven wrong (and costly).
Maybe this VIX pop is THE one, though.
Here's the VIX term structure from Friday (in red) compared with how the term structure looked one week after the last three times the VXX was higher a week after the VIX went overbought.
Quite the difference. VIX futures are way lower, which would seem to indicate that sentiment for a future VIX rally is way more tempered now. There's a big difference, though. The VIX itself isn't as high now as it was on those other instances. On Aug. 5, 2011, the VIX closed at 32.00. On May 11, 2010, the VIX closed at 28.32. And on Jan. 28, 2010, the VIX closed at 23.73.
When you adjust for the "spot" VIX level, VIX futures now don't look all that different from these other instances. And all three times, the VXX rally continued for at least a couple more weeks.
I have no idea if history will repeat itself. It is, after all, only three examples. And I really don't believe this is THE long-awaited macro turn in the VIX itself. But, it does suggest this intermediate VIX strength will persist a bit longer.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.