Two VIX 'Spin-Offs' You Should Be Tracking

How XIV and VVIX can signal the S&P's short-term direction

May 4, 2015 at 10:11 AM
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The following is a reprint of the market commentary from the May 2015 edition of The Option Advisor, published on April 23. For more information or to subscribe to The Option Advisor, click here.

So far, 2015 has been a year of choppy, range-bound action for U.S. equities, with the S&P 500 Index (SPX) netting a hard-won year-to-date gain of 2.6%. Meanwhile, the CBOE Volatility Index (VIX) -- a statistic reflecting short-term volatility expectations for the S&P, as measured by its option prices -- has plummeted 35%.

It's tempting to look at these two numbers and conclude that investors have grown "complacent," as several financial headlines have done lately. And it's certainly a tidy storyline -- after years of a record-setting bull market, traders have become dangerously content, and the market is surely due for a volatility spike! In today's increasingly competitive online media space, this angle has all of the right ingredients for a pageview bonanza: a somewhat esoteric indicator; just enough math to hint at statistical veracity; and an apparent cause for panic.

However, analyzing VIX (or the multitude of tradable volatility products that have sprung up around it) is rarely so easy, and it's almost never tidy.

For starters, there's the rather obvious logical fallacy in comparing the percentage gain for an index trading at 2,112 -- the S&P -- against the percentage loss for an instrument that finished Thursday at 12.48, as VIX did. Rather than weighing these apples-to-oranges percentage moves against one another, it's much more instructive to compare the S&P's 30-day historical volatility (HV) against the spot VIX. As of this writing, the S&P's 30-day HV stood at 10.8% -- which means, with VIX at 12.48, the current "VIX premium" stands at 15.6%.

By historical standards, this VIX premium is, indeed, modest. Our Senior Quantitative Analyst Rocky White reports that the median VIX premium has hovered in the mid-30s over each of the last one-, two-, and five-year periods. However, the current reading is not so "dangerously" low as to indicate that traders are fiddling while Rome burns. In fact, VIX premium has ticked higher from the lows set earlier this month; it bottomed at -1.1% on April 2. And, as the chart below reveals, the VIX premium isn't the most clear-cut predictor of S&P price action, anyway.

VIX Premium 0423

Moving beyond VIX itself to the increasingly vast universe of VIX derivatives, it's also worth noting a recent pair of notable milestones for the iPath S&P 500 VIX Short-Term Futures ETN (VXX). Per the iPath website, VXX "offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects market participants' views of the future direction of the VIX index at the time of expiration of the VIX futures contracts comprising the Index." Ostensibly, then, one might expect VXX to jump when VIX jumps, reflecting rising expectations for short-term volatility.

Unfortunately, due to the manner in which it attempts to proxy the value of a constant 30-day VIX future, VXX drifts consistently lower over time. Earlier this year, however, VXX embarked on a rare "winning" streak, wherein the exchange-traded note went 71 consecutive sessions without hitting a new all-time low. To give you an idea of how frequently VXX has plumbed record lows since it launched in January 2009, that 71-day stretch -- which ended on March 20 -- was its fourth-longest streak without a fresh nadir.

However, VXX's habit of creeping steadily toward zero certainly hasn't stemmed the flow of fresh capital into the ETN. From Feb. 2 through March 27, VXX notched eight straight weeks of inflows, totaling $833.12 million. It was the longest streak of inflows for the note since July 2012 -- a month where the VXX high stood at $241.60, on a split-adjusted basis (more than 11 times greater than the current VXX price of $21.10).

And during this eight-week period of rarely-seen-before inflows, with investors apparently rushing to bet on a short-term volatility pop, what did VXX do? Well, it didn't hit too many new lows, but it did lose more than 26% of its value. Even as VXX this month has resumed its regularly scheduled quest for new lows, inflows have continued, with the ETN netting $183.54 million through the first few weeks of April.

On the one hand, then, we have professional VIX-watchers warning of troubling levels of complacency in the market. On the other hand, we see traders pouring cash into a vehicle that's expected to surge when the market tanks -- even as that vehicle continues to bleed value. So, can the average investor glean any meaningful clues from the action in the volatility market right now?

In my own trading, I've found two VIX "spin-offs" in particular to be useful:

  1. Watch the VelocityShares Daily Inverse VIX Short-Term ETN (XIV), which moves inversely to VIX. Lately, when XIV trades above $40 and its 14-day Relative Strength Index (RSI) exceeds an "overbought" reading of 70, short-term S&P declines have followed.

  2. The CBOE VVIX Index (VVIX), which measures the expected volatility of VIX -- the "VIX of VIX," essentially -- has signaled a couple of major VIX spikes in the recent past. In both September and November 2014, VVIX moves below 80 preceded significant VIX pops.

As with all indicators, neither of these signals is infallible, with the latest "false positive" from VVIX occurring just last month. But adding XIV and VVIX to your existing arsenal of technical tools will provide valuable context to your market analysis, allowing you to more confidently navigate the next wave of headlines calling for a cataclysmic volatility explosion.


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