Rare VIX Signal Just Sounded for the 5th Time Ever

VIX premium peaked before the Brexit panic and the U.S. election surprise

Andrea Kramer
Oct 23, 2017 at 1:43 PM
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As just another example of the low stock market volatility of late, the CBOE Market Volatility Index (VIX) -- or Wall Street's "fear gauge" -- is flashing a signal so rare we've seen it just four other times since 1990. Specifically, VIX premium has crested above 200%, according to Schaeffer's Quantitative Analyst Chris Prybal, which was a really bad signal for the VIX in 2016. Below, we'll explain what VIX premium is, and what it could mean for the S&P 500 Index (SPX) going forward.

The lofty 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. In other words, it's a measure of how expensive the VIX is based on the SPX's previous 20 days' worth of trading. Mathematically, the VIX premium is simply [VIX - 20-day SPX historical volatility (HV)]/20-day HVs, expressed as a percentage. We considered only one signal every 21 trading days.

The last time it crested 200% was on Aug. 9, and prior to that just before the November election surprise. Before that, the VIX premium topped 200% on June 22, 2016, at the start of the Brexit panic. The only other time this signal has flashed since 1990 was in late December 2010. As you can see on the chart below, previous signals have preceded notable VIX drops.

VIX after VIX premium above 200


Six months after the last drop, the VIX was down 55.75%, per Prybal. After the June 2016 signal, the fear gauge was nearly 46% lower at the six-month point. And half a year after the late 2010 signal -- in which the VIX premium touched a record 289% -- the VIX was 10.59% lower.

On average, the VIX was down 37.42% six months after the signals. That's compared to an average anytime six-month gain of 4.36%, going back to 1990. In the shorter term, the VIX was in the red on average at every checkpoint starting at the one-week marker, and was negative 100% of the time three, four, and six months after a signal. That's compared to average anytime gains across the board.

VIX after signals vs anytime


Considering the "fear barometer" tends to drop when stocks are doing well, it's no surprise to find that the S&P 500 Index tends to outperform after these signals. Both two weeks and one month after a signal, the SPX was higher 75% of the time, with much bigger-than-usual gains. The index was higher 100% of the time two, three, four, and six months after a signal.

SPX after VIX premium above 200


In fact, the index's post-signal average one-month gain of 3.33% is nearly five times its average anytime return of 0.69% since 1990. Likewise, the SPX averaged a three-month post-signal gain of 6.48%, about three times its average anytime return of 2.06%. Six months out, the SPX was 10.1% higher, on average, compared to an average anytime gain of 4.22%.

SPX after VIX signal vs anytime


Of course, with just five signals total, the sample size is too small to jump to any significant conclusions just yet. Still, if recent history repeats, the VIX could be on track for record lows in single-digit territory, and the Chicago Board Options Exchange (CBOE) recently added an 8.50-strike VIX option for the first time in history.

Likewise, the S&P could be headed to even higher record highs over the next few months -- particularly considering "headline risks have been sufficient to prevent the kind of euphoric atmosphere that is prevalent at key market tops," according to Schaeffer's Senior V.P. of Research Todd Salamone.

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