Refining a trading system based on VIX's 10-day moving average
Okay, how about another way of parsing overbought CBOE Volatility Index (VIX)? I've generally advocated looking at the VIX "stretch" as a continuum. I use 20% above the 10-day simple moving average (SMA), but that's simply a round number that triggers a nice quantity of signals (about four per year). But VIX closing 19% above its 10-day "ain't nothing," even though it's a non-event in this system. Likewise, VIX 40% above the 10-day isn't the same thing as 20% above, even though it's treated the same.
So, here's the deal. We're going to break down VIX vs. its 10-day into ranges, and then look at one-month SPDR S&P 500 ETF (SPY) returns.
These are non-culled numbers; rather, it's just as if you walked on any day and look at where VIX closed vs. its 10-day. That leaves some redundancy in all readings. To put them in context, the randomly timed median one-month SPY return since March 1993 is 1.52%, and the average return is 1.13%. It suggests that at the high end, going long SPY when VIX is >20% above its 10-day SMA looks wise. But then it gets odd. It troughs between 15-20% above, then spikes again from 10-15% above.
If you prefer your data in graph form, it looks like this.
It's important to note that VIX spends relatively few days significantly deviated from the 10-day. Here's the quantity of days in the sample at each range.
The market does do well after VIX closes 20% below the 10-day -- but keep in mind it's only happened 21 times, or less than once per year. Extreme complacency is a signal in that it's likely a byproduct of some grand market worry evaporating. I could see it happening in December, in fact. We spend a month worrying about -- gasp! -- a rate hike. The rate hike happens, and VIX tanks on a combo of news out and seasonality. This small sample size suggests that's a bullish market setup.
The 10-15% above the 10-day zone is the most intriguing finding here. VIX closes there about 6% of the time, and it's a relatively good time to get long. Maybe that's the area where we should focus more attention.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research