The 20-day historical volatility (HV) has fallen below 6% for the first time in over a year
This week, I’m examining two volatility measures on the S&P 500 Index (SPX). The 20-day historical volatility (HV) has fallen below 6% for the first time in over a year, meaning the index has been especially calm over the past 20 trading days as the index continues to hit new all-time highs. The second volatility measure, the CBOE Volatility Index (VIX), reflects the expected volatility over the next 30 days based on SPX option prices.
Interestingly, while realized volatility (the 20-day HV) has collapsed, expected volatility has been rising resulting in an elevated VIX when compared to the HV. Below, I look at what all this could mean for traders.
Falling HV
Going back to 1994 (the first full year we have daily VIX data), there have been 12 previous instances of the 20-day HV on the SPX falling below 6% for the first time in at least three months. The table below summarizes the subsequent returns for the SPX after those signals.
The results are mixed, with the index doing well in the first week, averaging a return of 0.44 that beats the typical one-week return of 0.20% (see the second table below). But it seems to peak at about that time, as the average two-week return is lower (0.42%) and the one-month average return of 0.11% significantly underperforms the typical one-month return.
The longer term returns show slight outperformance. The median return doesn’t show the drop off at one-month, indicating it’s only a few signals that skew the results.
I wanted to look at the individual returns to see exactly what was going on with these mixed results. More specifically, I was interested the one-month timeframe. The table below shows the signal dates and returns. What jumps out to me is that in three of the last four occurrences, the SPX was down more than 5% over the next month.
VIX Premium to HV
As the 20-day HV of the SPX was falling to below 6%, the VIX was rising from the September low close of 14.71 to the close last Friday of 16.65, which was the day of the recent signal (the VIX is even higher now). That sent the VIX premium to HV above 180%, its highest reading since late 2021.
There have been seven instances where the premium moved above 180% for the first time in at least three months. The first signal was December 31, 2010, so the second table shows anytime returns since 2011 as a benchmark. Stocks have tended to perform very well after these instances. One month after these seven signals, the SPX averaged a return of 1.9%, with six of seven returns positive.
Here’s a look at the individual occurrences. I’m including the VIX close on the day of the signal. The last time was in late 2021 and this turned out to be one of the bad times to be long on stocks. The first two signals (2010 and 2012), with the VIX just below 18, were the times when the VIX was closest to the current level. Those were two very good buying opportunities in the short term.
High Premium with Low VIX
Finally, I found two periods in which we saw the VIX premium to HV reach 180%, while the 20-day HV of the SPX was below 6%. Those two times are shown below. Hopefully, this is a signal of what’s to come. The SPX was positive each times going forward, especially in the short term.
