Sub-11 VIX Could Mean Upside For Stocks

The Cboe Volatility Index closed below 11 last week

Senior Quantitative Analyst
Aug 15, 2018 at 7:19 AM
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Last week the Cboe Volatility Index (VIX) closed below 11 for the first time since January. The VIX measures the implied volatility of the S&P 500 Index (SPX) over the next 30 days. In short, the options market is expecting extremely low volatility, for the next month or so. Since volatility tends to move opposite of price action in equities, it’s not too much of a stretch to say the VIX is predicting bullishness for stocks over the next month. This week, I'll look at prior dips below this 11 level to see how often the options market got it right.

S&P 500 Returns When VIX Closes Below 11

Since the VIX started trading in 1990, there have been 10 other times that the volatility index crossed below 11 after trading above that level for at least three months (63 trading days to be specific). The table below summarizes how the S&P 500 performed after those instances. For comparison, I also show typical returns since 1993, the year of the first signal.

These signals have been bullish for stocks, just as the VIX (indirectly) predicts. The next month after these signals, the S&P 500 averaged a gain of 0.79% and was positive 80% of the time. The more impressive returns were further out. The index was positive nine of 10 times when you go to three and six months, and the average return easily outperformed the typical average return at those longer time frames. These VIX signals also got volatility right: The standard deviation of returns after these signals are much lower than normal.

;S&P 500 After VIX Closes Below 11

The one-month returns above, while bullish, were the least impressive of the three time frames I looked at. However, look at the individual occurrences in the table below. The index returns were positive the last eight times in a row. If you get rid of the two negative 1993 occurrences, the one-month returns averaged a gain of about 1.4% and are positive every time.

S&P Individual Returns VIX Below 11

The VIX After Closes Below 11

So, we looked at how the S&P 500 does after these signals, but what about the VIX itself? Though the VIX tends to move opposite of stocks, in this case, with the VIX hitting such a low level, you typically get a higher VIX going forward too. Over the next month after these signals, the VIX gained on average 17.3%, with nine of 10 returns positive. Looking at just the last eight occurrences (when the S&P 500 was positive every time), the VIX averages a gain of 13.6%. The one time the VIX fell, it fell less than one percent.

VIX Returns After VIX Close Below 11

In conclusion, these signals have been a good sign for stocks going forward. Based just on these numbers, there is an increased probability of low volatility and higher stock prices over the next few months. The VIX, based on this, is probably close to a bottom.

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