VIX Futures and Volatility Aftershocks

CBOE Volatility Index (VIX) futures can't let go of the recent volatility pop

by Adam Warner

Published on Sep 10, 2015 at 10:14 AM

The volatility pop is over. Really, it's over. Or it's not -- I don't really know the answer. I do know it's probably "old" enough that we can make some better observations. 

Remember way back when, that halcyon era before the CBOE Volatility Index (VIX) would do things like double in a couple of days and soar way beyond its "mean"? I used to consider a move 20% from its simple moving average (SMA) a mean reversion. And I tracked market performance going forward from there. 

Well, I can update my table a bit now. Here's the look back just to 2009:

150910Warner1

Since I declare it a signal when VIX closes more than 20% above its 10-day SMA, flares went up with VIX at 19.14 -- on the way, of course, to a high close over 40 a mere three days later. SPDR S&P 500 ETF (SPY) was 203.97 on the way to a closing low 16 points below that. So barring a continuation of the rally, the one-month number is going to look bad. At best, the timing was terrible. The three-month trade from the signal way back at the end of June is going to look very bad as well. 

I also look at what happens if you buy when VIX closes 20% above, and then close when VIX closes back under the 10-day. That took nine days to play out and lost a whopping 4.22%.

The lesson, of course, is that mean reversion works until it doesn't … in a big way. Do it every time and you'll come out ahead in the shorter-term trades, but there's some serious occasional pain. 

Even though VIX itself didn't reach epic levels, this vol pop was historic in terms of the speed of the move, no matter how you defined it. We're still clearly in the aftershock phase, and VIX futures aren't at all ready to throw in the towel. Here's the term structure, now including those Weeklys that we mentioned yesterday!

150910Warner2

Yes, most futures trade at a discount to actual VIX, but the absolute levels remain in the 22-23 range. They more or less price in that this vol will be our backdrop going forward. That remains quite the contrast from how the term structure looked on Aug. 21, when VIX first ripped through here.

150910Warner3

We've sat in a long-term Low Volatility Regime for five years or so now, depending on how you define it, and that's about the average length of time before the trend tends to shift. Thus it's not out of the realm of possibility that the assumptions embedded in the term structure will prove prescient. I'd just note that the VIX complex is always bullish on future VIX.

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


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