Indicator of the Week: Should You Sweat the VIX Spike?

This is the smallest SPX drop amid a simultaneous VIX spike since 1990

Senior Quantitative Analyst
Jun 15, 2016 at 1:04 PM
facebook twitter linkedin

The CBOE Volatility Index (VIX) uses S&P 500 Index (SPX) options to show the market's expectation of volatility in the next 30 days. Because volatility rises most during sharp downturns, the VIX is often referred to as the market's "fear gauge." In a little more than a week, the VIX has spiked more than 50%, indicating heightened fear. However, I'm wondering if this spike is really justified. The SPX over that same time fell less than 1%. What do these VIX spikes tell us about the market going forward?   

Simple VIX Spikes: First, does the simple fact that the VIX spiked 50% in less than 10 trading days tell us anything? The first table below shows how the SPX performed after VIX spikes, going back to 1990 (where we first have VIX data). The second table shows typical SPX returns since 1990 for comparison. 

Interestingly, you do see some stock underperformance a month out after these spikes, when compared to the typical market returns. The S&P averages a negative 0.62% return in the next month after a VIX spike, while the market typically gains 0.68% over a one-month time period. The percentage of positive returns, though, isn't that different (58.3% after a VIX spike vs. 62.0% anytime). The main reason for the underperformance is the higher downside volatility. This is evident in the average one-month negative return after the VIX spike -- a loss of 5.88% -- compared to the typical loss of 3.52%. Big gains in the VIX have led to downside volatility over the next month. 

 spx returns after vix spikes

VIX Spikes on SPX MovesA large VIX spike like the one we saw recently typically occurs during a significant drop in stocks. However, this time, the S&P 500 fell less than 1%. In fact, of all the VIX spikes, this last one coincided with the smallest move in the SPX. So, is this an overreaction? For an answer to this, I broke down those one-month returns after a VIX spike by the corresponding S&P 500 return. The table below summarizes the results. 

The results aren't too conclusive, in my opinion. When stocks fell less than 4% during the VIX spikes (like now), the SPX averaged a loss of 0.71% over the next month, but was positive about 64% of the time -- which is higher than the other two brackets. Those 11 returns when the S&P fell the least showed more downside volatility compared to upside volatility. The worst-performing bracket is when the VIX spike is accompanied by a very big drop in stocks. When the S&P 500 fell 7% or more during the spike, the index went on to lose an average of 1.69% over the next month, and was positive 54% of the time. By both measures, it's the worst of the three brackets. 

spx returns after vix spikes 1 month

Finally, the table below shows each individual occurrence of the VIX spiking on a small drop in stocks. The next-smallest drop before this last one occurred in 1990, and the S&P 500 went on to lose over 9% in the next month of trading. Another time, in 2010, the index fell 8.66% over the next month. 

However, we can take comfort in that losses only happened four of 11 times -- and one of those losses was less than 1%. Anecdotally, the fact that the VIX spiked so high on a relatively minor drop in stocks tells us how on-edge investors are, even with the S&P 500 less than 2% away from all-time highs. To contrarians like us, that heightened fear can have bullish implications going forward. As the saying goes, "be greedy when others are fearful."

spx returns after vix spikes on small stock drop

Sign up now for a trial subscription of Schaeffer's Expiration Week Countdown! We'll send you 5 trades for expiration week, each targeting double- or triple-your-money gains in less than 5 days.

Now is the time to join our thriving community of Event Traders who consistently profit from every earnings season. With this discounted subscription opportunity, you'll stay ahead of the curve and seize opportunities others miss. Do not let Q3 earnings season pass you by – subscribe now and supercharge your portfolio with expert insights that turn market reactions into profit-generating opportunities!! Don't waste another second... join us right now before the next trade targeting +200% is released!