Stocks quoted in this article:
Well, I guess all that interest in put ownership lately was pretty prescient. Or coincidental. Or whatever. There's no dispute that the character of the market and volatility changed in a big way last week.
The CBOE Volatility Index (VIX) closed 32% above its 10-day simple moving average on Thursday, the second distinct "pop" in two weeks. The first pop was in reaction to a pretty tiny stock drop, relatively speaking. This second one was a bit more serious; 40 handles in the S&P 500 Index (SPX) is less impressive, on a percentage basis, when there's a full of 1,950.
On the other hand, it was a pretty respectable move within the current volatility backdrop. A VIX of 12 implied that the market priced in a "typical" daily range of about 0.75%, and we got roughly three times that on Thursday. VIX, over the course of forever, averages around 20 -- so it was akin to about a 4% drop in a perfectly average volatility backdrop. So, nothing to sneeze at.
As you probably guessed, our good friend iPath S&P 500 VIX Short-Term Futures ETN (VXX) has done much better lately. It hasn't made an all-time low since July 3! So, volatility assumptions had nudged up a bit before last week's surge. For the week, it lifted 15%!
That's the good news. The bad news is that unless you bought ahead of the pop, it's pretty unlikely it makes much sense to load up now. Here's a table of VXX performance if you bought and held for five, 15, and 25 trading days, starting on the close of the first day VIX closed >20% above its simple moving average.
The "Random Average" shows what happens if you buy and hold VXX for any random five-, 15-, or 25-day stretch. And on that basis, it looks like a less-bad time to buy and hold a terrible product.
But alas, that misleads a bit. As you can see on the table, you almost always lose on the trade, with one big exception -- the July 29, 2011 episode. At the bottom of the chart, I show the median results, and your typical experience buying VXX after the VIX pop is way worse than just randomly buying VXX in the five- and 15-day windows. In the 25-day window, it's close to a wash.
So it pays to buy VXX early, right? Well, not at all. Unless you can predict when it's going to pop, you will almost always lose buying and holding it. All the numbers above are negative; it's just a question of how bad.
There is a big elephant in the room, though: The fact that this big VIX pop is almost three years to the day after the last VIX pop that begat some serious market ugliness. So, perhaps we're in for a rerun?
Well, I wish I knew the answer. All I can do is highlight that sample sizes of one are never good to rely on, and throw in some other data. VIX and SPY were in very different places in July 2011. VIX closed at 25.25, and SPY closed at 129.33. Here's a graph of the VIX term structure then vs. now.
The slope is somewhat similar to the naked eye, but with one big difference. The entire board was already at a discount in 2011 ... remember, VIX was over 25 at the time. Now, only the nearer months are at a discount. On the other hand, we can't ignore that the absolute numbers are so much lower now, so there's not much preparation for a more serious and lasting VIX pop.
So while the calendar looks like it did in 2011, the backdrop otherwise does not. One of these VIX pops will inevitably linger. And this one certainly has an ugly start. But there's truly no way to know this early in the ugliness whether it keeps on going like it did three years ago.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.