Schaeffer's Trading Floor Blog

What to Make of the 'Overbought' VIX

Last week's VIX spike was pretty tame, relatively speaking

by 7/21/2014 8:49 AM
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Don't look now, but we have an "overbought" CBOE Volatility Index (VIX)!

... Well, we had an overbought VIX, briefly. I use the VIX closing 20% above its 10-day simple moving average as my strict objective definition of overbought, and we got there on Thursday.

So, let's update the table we just ran a couple weeks ago on overbought VIXes since July 2009.

SPY Performance After a VIX Breakout

Just to refresh, this table shows all 16 instances of my definition of an overbought closing VIX since the beginning of July 2009. I also included the SPDR S&P 500 ETF Trust (SPY) return if you held for one month and for three months. At the bottom, I show the mean and median returns, as well as the returns if you just randomly bought and held for one or three months.

Obviously, we don't know yet how this latest VIX pop plays out, but it's certainly off to a good start. Friday's rally just about offset Thursday's dip. Maybe that was a fake out or a squeeze, and we dip again or maybe Thursday was just a head fake.

It's not too early to make some observations, though.

The overbought VIX came almost right on schedule, to the extent this sort of thing has a schedule. It's tough -- and pointless -- to guess when exactly it's going to happen, but we can safely say it's an event we see about three times a year or so. And given that it was nearly half a year since the last blast, it was simply time.

The ostensible cause was the tragic Malaysia Airlines jet crash, specifically, and global unrest, generally. But a better way to look at this is that the market was due for a shakeout anyway, and this was merely the catalyst. If you like historical parallels, see the April 15, 2013 overbought VIX the day of the Boston Marathon bombing.

Both events are tragic, both understandably get investors a bit scared and cautious, but ultimately, neither is likely going to lead to the end of any long-term move. Quite simply, we all collectively have the attention span of fruit flies. One day, every story on financial news is about the sad events, and every pundit and everyone with a Twitter account is an expert on the subject. And then a day or maybe a week or two later, no one cares, at least as far as investing goes.

Ukraine's not getting resolved any time soon. Nor is Gaza, to name last week's other notable unrest. And neither is going to affect investing all that much over time.

To me, the surprise was that we turned around so quickly, and on a Friday no less. Often, investor fears run rampant going into three days of uncertainty. Not so much this go-around.

As for the VIX itself, this marks the lowest absolute level for any of these recent "overbought" events. In fact it's the lowest by a lot, 14.54 vs. 17.27 in April 2013. The median of all VIXes since July 2009 is 17.81, so we're considerably below a typical VIX reading in a low-VIX regime. In other words, "overbought" hardly equals panic right now anyway.

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

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