Schaeffer's Trading Floor Blog

Volatility Pop and Drop

Was the latest volatility spike and drop a blip, or a warning sign?

by 2/9/2014 8:57 PM
Stocks quoted in this article:

Well, volatility has sure gotten volatile lately.

The CBOE Volatility Index (INDEXCBOE:VIX) closed at 21.44 on Monday, marking the highest close since late December 2012. It hadn't ceded much by Wednesday, as it had dropped just to 19.95. What followed, of course, was a big two-day rally in the market and a sizable plunge in VIX, taking it down to Friday's close of 15.29.

At that price, VIX has erased virtually all of its gains since the sell-off began. VIX closed at 13.77 on Jan. 23, meaning we're about one or two more strong days away from pretending this all never happened.

As impressive as the 28.7% drop in VIX looks over four days, it's even more impressive when you consider how it has fluctuated around its moving averages lately. On Jan. 24, VIX peaked at 34.7% above its 10-day Simple Moving Average. By the end of Friday's volatility drop, VIX closed 14.2% below the 10-day.

That's one of the bigger oversold readings you'll see. It is indicative of complacency, but unfortunately, complacency rarely gives us good timing tools in the market. Part of the reason is that "oversold" VIXes tend to occur at times like these. Namely on drops after VIX pops, because just as the moving averages catch up to the VIX rally, VIX itself stops rallying.

VIX futures always lag a little as they assume mean reversion. We saw the curve get almost flat earlier in the week, with the whole board under VIX itself. The futures clearly "knew" VIX would dip back OK, I kid. Futures really don't "know," and they're wrong more often than right.

But how about now? Same as it ever was.

Chart of VIX futures term structure since February 2013
Chart courtesy of VIX Central

Quite the contrast with how the curve looked all the way back on Monday.

Chart of VIX futures historical prices
Chart courtesy of VIX Central

The futures had the concept on mean reversion right, as VIX did drop. But they didn't exactly get the magnitude correct, especially in the nearer months ouch.

That of course bashed our good friend the iPath S&P 500 VIX Short-Term Futures ETN (VXX). From the closing lows of $39.97 on Jan. 22 to the peak close last Wednesday, VXX lifted 34.8%. Then over the next two days, it gave back about 60% of those gains.

On the plus side it basically kept pace with VIX!

All in all, a pretty interesting stretch for All Things Vol. Was this just a blip, or a warning shot of things to come? Only time will tell.

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

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