The Missing Ingredient for a VIX Melt-Up?

The Cboe Volatility Index is moving higher off its year-to-date floor in the 12 region

by Bernie Schaeffer

Published on Dec 3, 2019 at 7:51 AM
Updated on Dec 3, 2019 at 7:51 AM

The notion of the Cboe Volatility Index (VIX) being "high" or "low" is, as you're likely aware, entirely a matter of context. During calendar years 2010 through 2016, the average daily VIX reading was 17.92 -- not sky-high by any means, but still a figure that would have seemed downright panicky during the year-long bull-market blowout of 2017, when VIX's average daily print checked in at a virtually unflappable 11.09.

Over the last two years, VIX has settled somewhere in between those two checkpoints. The average daily reading in 2018 was 15.96 through the end of November -- a figure that would ultimately nudge higher to 16.64 by year-end, as equity losses accelerated into the close on Christmas Eve. And through the close on Wednesday, Nov. 27, the average daily VIX for 2019 to date was 15.55... more than 32% above 11.75, which is where VIX settled for the session.

As a matter of fact, the three pre-Thanksgiving sessions last week marked a string of fresh year-to-date low closes for VIX -- all occurring below the 12.00 level, meaning the index was down more than 50% on a year-to-date basis. Prior to that daily closing streak, Friday, Nov. 15 was on our radar as only the sixth session in calendar year 2019 that the spot VIX printed below 12 on an intraday basis, with the previous instances clustered in mid-April and late July.

In the current volatility environment, these spot VIX prints below 12 are not what you want to see if you're short the "fear gauge" -- at least, based on the last two data points. The VIX pop in May followed the initial April 12 "spot < 12" date by 21 calendar days; meanwhile, the VIX spike in August took place only eight calendar days after the July 24 sub-12 print.

We already saw VIX moving higher off its extreme lows in Friday's session, although the 7.4% climb back above the 12 level didn't exactly rise to the level of a "volatility explosion." As a point of caution, however, at least one of the ingredients for a further VIX pop is in place, as the weekly Commitments of Traders (CoT) report continues to show large speculators in an extreme net short position on VIX futures -- a condition that preceded prior ramps higher in the volatility index, as this group reached previous net short extremes in late April and late July of this year.

That said, one thing we're not seeing -- at least, not yet -- is the kind of heavy-handed VIX call buying that preceded those two major volatility spikes earlier this year. Per the chart below, the 20-day buy-to-open call/put volume ratio for VIX options peaked at 5.12 just prior to the May pop in the VIX, and jumped as high as 7.39 directly ahead of the August volatility surge. But this ratio has been trending steadily lower in recent months, and was docked at a middling 2.11 ahead of the Thanksgiving holiday.

While the recent string of sub-12 VIX closes is cause to proceed with caution, remember that when it comes to the VIX, context is everything. If the spot reading remains low and large speculators remain steadfast in their extreme net short position, a rise in call buying may be the final "ingredient" needed to trigger a VIX "melt-up." With that said, there's also the possibility for a less-explosive, gradual resolution with "the VIX continuing to work higher amid little to no damage in the equity market," as Schaeffer's Senior V.P. of Research Todd Salamone recently described it -- all the more reason to keep a watchful eye on sentiment cues as the VIX moves off this key year-to-date floor.

vix call-put ratio 1129

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, December 1.


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