VIX and the 'Absolute vs. Percentage' Debate

Is it better to measure VIX moves in absolute or percentage terms?

by Adam Warner

Published on Sep 24, 2015 at 9:34 AM

When it comes to quoting market moves, what makes more sense: percentage moves or absolute moves? It's pretty clearly percentage moves. I mean, the '87 Crash was a drop of 508 Dow Jones Industrial Average (DJIA) points -- which sounds pretty pedestrian in those terms by today's standards, where the same point drop would equate to 3%. In 1987, though, it wiped out 22.6% of the market's value in one day.

It doesn't have to be a crash, though, to make percentages preferable. "A drop of 1%" better contextualizes an S&P 500 Index (SPX) move than "a drop of 19.5 points."

But none of that is necessarily true when it comes to CBOE Volatility Index (VIX). I generally analyze and express VIX moves in percentage terms, but at times it makes more sense to use absolute terms. If VIX is very low, for example, percentage terms exaggerate and generally misrepresent the significance of moves.

Say VIX goes from 10 to 11. That's 10%! It sounds like a lot. It's also 1 point, and that sounds more like a rounding error. That's especially so when you consider VIX is simply a calculation and it's subject to quirks around days of the week, holidays, and the time of year in general.

The effect of using percentages instead of absolute moves mutes as VIX gets higher, but it's still a factor and can lead to fuzzy conclusions. I also believe absolute terms are preferable when comparing implied and realized volatility.

Ten-day realized volatility (RV) is a somewhat noisy number, and it can get very low at times. You might see cases where it's something like 8, while VIX is 12. If you use percentage terms, then we'd say implied volatility (VIX) is 50% above 10-day RV! It sounds fat… and it's very misleading. It's way better to compare the two in absolute terms. In this case, implied vol is at a 4-point premium to realized vol, which is… historically very normal.

On the other hand, we shouldn't disregard percentages. Take the recent VIX pop over the past month. To me, expressing it in percentage terms made perfect sense. VIX moving from 15 to 25 is indeed more significant than, say, VIX moving from 40 to 50 (which we did actually see intraday). Why is that?

Well, VIX translates to a standard deviation, and we can translate that to a percentage move in an underlying index that is factored into the options prices. Thus, if VIX doubles, it essentially doubles the "coverage" of an SPX move. Think of the guy who sold options into a VIX pop. He's not hurting theoretically* until the stock move or range exceeds the implied vol he got for his options.

(*I say theoretically because implied vol moves too. Maybe stocks themselves are contained, but if implied vol explodes in his face, that's also painful.)

My point is that from this angle, it's the percentage move in VIX that's more important, not the absolute move. All in all, though, we need to incorporate both absolute and percentage moves into our analysis. There are pluses and minuses to each approach, and the last thing you want to do is ignore one of them.

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

A Schaeffer's exclusive!

The Expert's Guide

Access your FREE trading earning announcements before it's too late!



NEW! Explore Schaeffer’s Partners' deals and get connected to top online brokerages with deals tailored exclusively for our readers.  Get answers to your questions regarding transfer fees, commission rates, programs and available discounts related to online trading services.

MORE | MARKETstories

The Nevada Discovery That Could Jeopardize Chinese Dominance
Click to continue to advertiser's site.
Analyst Goes Bearish on Anthem Stock
Jefferies downgraded Anthem stock to "hold" from "buy," and cut its price target to $257
UNH Stock Pops on Accelerated Payment Promise
Analysts are very bullish on UnitedHealth stock
The Top Lithium Play of 2020
Click to continue to advertiser's site.