The VIX: Analyzing 'The Big One'

VIX skyrocketed during a short week and amid a seasonally quiet time of year

Jul 6, 2015 at 9:09 AM
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I hope everyone had a fun week last week. As I noted recently, we were in a somewhat extended period since the last "Official" CBOE Volatility Index (VIX) Pop. But, since it was a pre-holiday week amidst the worst time of the year for volatility, I took a few days off. Hey, what are the chances the Vol Pop happens right before July 4th?

Apparently, about 100%. We've had Greek news and deadlines and threats and counter-threats and threats to the counter-threats for five years now. But this turned into The Big One.

There's no certainties to any of the "predictions" we all make. At least, there shouldn't be. In the real world, we deal more in probabilities. You will make money if you find situations where there's a disparity between the expected probability of an event and the probability the market assigns to that event. For the lion's share of the last six years, the market has consistently overpriced the odds of an imminent volatility pop. By and large, it pays to fade that overpricing. 

But that doesn't mean those Vol Pops don't happen. They always do, and clearly when I least expect them. I did expect one sometime in the next couple of months; I didn't expect one last week. 

Anyway, at least it gives us a good excuse to open up the VIX Pop Table! Just to refresh, I use "20% above the 10-day simple moving average (SMA)" on a closing basis as the official definition of an Overbought VIX. And below is a rundown of Overbought VIXes since 2009.

I include the one-month and three-month returns of a long initiated at the close of the first session VIX closed 20% above its SMA, as well as returns of a long that's closed after the first session where VIX closed below its 10-day SMA. Also, I note the duration of that trade (in trading days) as well as the duration from the first Overbought VIX until the nearest SPDR S&P 500 ETF Trust (SPY) bottom. If it's zero, the first day of the Overbought VIX was the bottom. I also include the mean and median one-month and three-month returns of trades initiated on any random day since 2009.




As you can see, fading Overbought VIX has been a generally good idea over the last six years -- at least in the near term. Buying and holding until VIX closes back below the 10-day has had a median return of 0.84% with an average holding period of slightly over a week. Further, the trade "won" 12 of the last 15 times. 

Going a little further out, holding for a month has had a median return of 4.08% vs. 1.61% on randomly timed one-month holds. It's also on a nine-"game" win streak, albeit with the tiniest of wins last July. 

By three months, the Overbought VIX has no real impact on returns. I can take a rose-colored lens to that, though, and point out that anyone who tells you the VIX pop "predicts" future doom and gloom in the longer term needs to show some real data to back those assertions up. 

Oh, and a reminder: I don't want to double-count data, so the blanks on the table are to avoid overlaps. 

It's important to note that all of this looks back on an era that we know in hindsight was a bull market coupled with a low VIX "regime." We don't know that's the case going forward, of course. One of these VIX pops will "stick." Maybe it's this current one, though as always, it's way tougher to call a change in trend than it is to simply stay on the same path. 

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

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