What to Make of the Latest 'Overbought' VIX Signal

The VIX has spiked above its 10-day moving average as the market has sold off, but this has been a historically bullish indicator

Aug 24, 2015 at 9:07 AM
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It seems like only a week or two ago when I last complained about churn. Damn, I miss those days.

We've gone from lazy churn to downright panic in the course of a few days. And make no mistake, this is a panic for the ages, at least as far as our CBOE Volatility Index (VIX) goes.

VIX closed 81.7% above its 10-day simple moving average (SMA), the biggest stretch ever. We usually use 20% above the 10-day SMA as a trigger, and it only happens about 3-4 times per year, including Thursday.

Thirty percent above the 10-day? I show it happening 43 times total since early 1993. That's 5,690 trading days. And even that overstates it, as some of those are bunched and essentially part of the same "incident." If I winnow out bunched dates, I show 21 separate incidents of VIX 30% above its 10-day SMA. Again, that's in a 22.5-year time sample -- so, as best my "back of the envelope" math tells me, that's less than once per year. And here are they are:


Yes, the current pop only "counts" as a 36% violation using the 30% threshold. As you can see -- thanks to my wonderful color coding -- the SPDR S&P 500 ETF Trust (SPY) returns look pretty good when you buy after a close this extreme. Six of the seven top incidents with larger violations than this one saw one-month and three-month returns nicely above typical one-month and three-month returns.

What if we increase the threshold to 40%? We're down to eight incidents, including the current one:


It's only seven priors, but the returns look pretty strong. The worst case three months out was buying in May 2010 -- just before the "flash crash," as it turns out. You were basically flat. The next worst case was April 1994, and you had returns almost exactly the same as buying on some random date. Every other time, you did very well. Overall, it's a 7.85% average and 9.13% median vs. 2.06% average and 2.79% median on a randomly timed purchase.

You did very well buying and holding for one month as well -- 2.93% average and 3.05% median vs. 0.68% average and 1.11% median. There was one accident -- the flash crash.

The sample size is low, and again, we do crash from oversold. But odds are we got a bit extreme here, and it may be a good time to buy if you can stand some pain along the way.

And one thing that I think is important to note: All of the above mega-extremes took place in otherwise decent markets. There are no 2008s or 2002s thrown in. That's because those were longer-term ugly stretches amid already rising volatility. These were more sudden bursts. Maybe it's like February 2007 and it's an early warning shot. But remember, even then, the market recovered and made new highs into October.

What's conspicuously absent? The Crash of '87. VIX didn't exist then, and neither did SPY, for that matter. But alas, we can get back there in a way -- and we'll do exactly that later this morning, in Part 2 of our analysis.

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

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