What The VIX Premium Is Saying About Stocks

VIX premium means short-term S&P 500 Index (SPX) options are overpricing volatility expectations for the month ahead

Mar 1, 2017 at 1:43 PM
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The S&P 500 Index (SPX) hasn't suffered a drop of 1% or more since October -- a historically bullish signal, as Schaeffer's Senior Quantitative Analyst Rocky White pointed out. With stocks assailing record heights, options traders are scooping up CBOE Volatility Index (VIX) calls at a rapid-fire rate. But the currently vast divide between historical volatility and expected volatility suggests VIX could actually be due to cool further while the stock market continues its rise.

The VIX 20-day buy-to-open call/put volume ratio recently spiked to 6.60 on Feb. 27, marking the most elevated reading since July 2007, according to Schaeffer's Quantitative Analyst Chris Prybal. The "fear index" has traded sideways since early January, with lows mostly in the 11.25 area -- half the VIX's pre-election closing peak at 22.50.  

VIX BTO call put ratio options

The VIX premium, for those unfamiliar with the concept, reflects the degree to which spot VIX exceeds the 20-day historical volatility of the S&P. In other words, a VIX premium indicates short-term S&P options are "overpricing" volatility expectations relative to the volatility the index has actually realized over the last four weeks' worth of trading.

Due to the aforementioned low SPX volatility, the index's 20-day historical volatility bottomed out Tuesday at 4.61, while VIX settled the session at 12.92 -- sending the VIX premium north of 150%. That's the first time the VIX premium has exceeded this level since October 2016. Below is how the S&P 500 Index tends to perform following these relatively rare signals, of which there have been only a dozen since 1990 (counting one signal every 30 trading days).

SPX signal VIX premium high

While the SPX tends to underperform its comparable "anytime" returns up to one week after a signal, the index handily outperforms from the one-month to the six-month periods. For instance, one month (21 days) after a signal, the SPX has averaged a gain of 1.98%, and was higher 75% of the time. That's compared to an average anytime one-month return of 0.69%, and positive just 62% of the time, going back to 1990.

What's more, six months after one of these excessive VIX premium signals, the SPX has averaged a healthy gain of 6.37%, and was higher a whopping 80% of the time. That's a great deal better than the SPX's average six-month return of 4.18%, with 73% positive. 

The signal also tends to precede an even lower VIX. Aside from the three-day and two-month (42-day) markers, the VIX has averaged a loss over the intermediate-to-long term. In fact, the VIX has been down an average of 1.89% six months after a signal, and higher just 30% of the time. Since 1990, the VIX has averaged an anytime gain across the board, and was up 6.63%, on average, at the six-month marker.

VIX premium signal

"This signal usually occurs in bull markets, and similar to other studies on lengthy low-volatility bull markets, strength begets strength," Prybal stated. However, it's worth noting that large speculators remain in an extreme net short position on VIX futures, per Commitments of Traders (CoT) data, and these traders have been wrong at major turning points in volatility, as Schaeffer's Senior V.P. of Research Todd Salamone noted in Monday Morning Outlook. And that's just one of the mounting signs of a volatility pop

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