Has the VIX Dropped Too Far, Too Fast?

As stocks have rallied, the CBOE Volatility Index (VIX) has plunged in October

by Adam Warner

Published on Oct 30, 2015 at 9:12 AM

Has the CBOE Volatility Index (VIX) gone down too far, too fast? Seeking Alpha asks:  

Volatility Update: 40% Plunge For VIX = Market Vulnerability? 

"The S&P 500 (SPX) staged a nearly 7% rally in the first three weeks of October - action that crushed several measures of stock and commodities. 

… The broad stock market mood measure, the CBOE Volatility Index (VIX), dropped some 40% month to date through Friday. VIX recently dropped to two-month lows and to levels not seen since before a major spike in late August. Recall that the volatility index hit an extreme of 53.29 during the panic market sell-off of August 24. Just a few weeks earlier, VIX was at the lower end of the 2015 range and had hit 52-week lows below 11." 

OK, I'll take the bait. No, it doesn't signal anything in particular, in terms of market vulnerability. In fact, the writer basically answered the question right there. VIX is down 40% precisely because the market lifted the 7%. 

That's a VIX Move/SPDR S&P 500 ETF (SPY) Move ratio of about 5.71. And that's very much in line with history, as well as behavior we've seen in 2015. 

Over the course of forever, VIX has moved about -3.85 the move in SPY in a typical day. But that relationship has trended stronger over time, particularly this year. For 2015, that ratio has spiked to -7.92. 

Here's a chart of the rolling 20-day ratio this year: 

151030Warner

Remember, this is a negative relationship, so lower is actually stronger. And as you can see, this actually peaked a few weeks ahead of the market melt. In other words, VIX got very reactive to SPY moves in the month or so preceding the market dip. Since then, it's actually trended less reactive, though that trend has flatlined in October as the market has spiked. 

What's more, implied volatility (IV) is very much in line with realized volatility (RV). The 10-day RV in SPY is about 12 now; we're at a very normal premium. 

I'd only worry about VIX here if you're predisposed to want to worry about something. I mean, we've had a nice rally -- it's natural to expect a pause. I just don't think the VIX in any way, shape, or form is suggesting anything of that sort right now. 

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


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