Schaeffer's Market Mashup Podcast: Breaking Down the VIX in 20 Minutes

We break down what the "fear gauge" really is

Managing Editor
May 14, 2021 at 10:00 AM
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On the latest episode of the Schaeffer's Market Mashup podcast, the "fear gauge" VIX had a roller-coaster week, so along came our good friend, Adam Warner, for a quick-hitter episode about the Cboe Volatility Index. Warner clarifies what "fear gauge" really means (3:25), why these spikes keep happening (5:45), how to read a VIX chart (8:20), and how to react to the next breakout (10:15)


Transcript of Schaeffer's Market Mashup Podcast: May 14, 2021

Patrick: Before we get to this week's episode, I want to take a second and highlight what we've been working on over at Schaeffer's. You've no doubt heard of the popular sell in May and go away trend. Well as contrarians, we recently identified five stocks that are poised to buck that trend and enjoy strong growth this summer. It's only available for a limited time. So head over to the link in this episode's bio to get the free report. Can you confirm folks? I did say free, it's free. Check it out. Without further ado Adam Warner.

Patrick: Ladies and gentlemen, welcome back to the Schaeffer's Market Mashup, but also please welcome back Johns Hopkins most renowned options trader and scribe Adam Warner, who was kind enough to fill in this week in the last minute to talk some VIX. Adam, welcome back. It's good to have you back on.

Adam Warner: Thanks for having me back, Patrick. 

Patrick: Let's talk about the elephant in the room. First I have to congratulate you. Your New York Knickerbockers have secured their first playoff berth in what feels like eons, but really only what? 2011, 2014. 

Adam Warner: I think it's 2013. It seems like a lifetime, they've only won like one playoff series in 20 years. Something like that. I think it was 2013. 

Patrick: I'm pretty sure it was against the Celtics.

Adam Warner: I don't remember.  

Patrick: Yeah. Geez. It's seven-plus years, time is flying, but yeah, it was like the Jr Smith, Carmelo Anthony team. God, I hated you all. 

Adam Warner: Except for Carmelo Anthony. 

Patrick: Yeah I like this Knicks team and unlike most Boston fans, I think when the Knicks are good and Boston teams are good, it's just better for basketball and it's better for sports in general.  And on that note, you got the Nets in first place. So I mean, you couldn't be happier.

Adam Warner: Yeah. They're on fire. They're playing teams but you still gotta beat them. So they won up to 7 in a row. So hopefully I can keep it up.

Patrick: Red hot. Yeah. like my dad said, you can only beat who's in front of you. Let's get to the point here. It's great timing, honestly, having you on, for someone who has on his Twitter profile In VIX we Trust, between the broad market sell-off, the inflation fears, then kind of like the slivers of good news coming with the CDC and in the reopening of everything. The VIX has been all over the place the past three days, starting at under 17 or dipping under 17, getting over to 27 and then even it recovered a little bit today, dropped below its 200 day moving average and then reclaimed it. It's all over the place. So I want to at least start simple. If someone who doesn't have an experience with the VIX or what the CBOE volatility index is, they come across an article and then they say, you know, the fear gauge hit its highest level since March, as the rest of the market is selling off. What does that tell a retail investor?

Adam Warner: Generally speaking, I mean the VIX, we nicknamed it the fear Index. The VIX involve totally on index options basically. And it moves inwards to the market. The S&P goes up, VIX tends to drift down and S&P goes down and VIX tends to inch up, but, you know, S&P is moving down a bit faster this week. So the VIX is going to go up. It's just really a question of magnitude. It's useful when it kind of overreacts to a market move and that's a bit what we've had this week. From bottom to top, let's say it's about 10 points. So that's, you know, like 60% or so. It is a little dangerous using percentages because it's often a low number, but that's still a pretty big move.

I like to look at it as versus it's moving average and 10 day moving average. It used to be that when it got about 20% over the 10 day moving average, that was somewhat of a bullish signal because it kind of meant that options were getting a little too fearful, but this week it closed yesterday, it closed a little over 40% above, which it's not unheard of, but it's been unusual. And that's just a bit on the high side. So it's far from fullproof,  that happens in crashes also like last year. But generally speaking, that's an indicator that it's got a little too far, too fast. And again, this is pretty quick, it was something that happened over a couple days. Last Friday, VIX closed. I think it closed at 16.69 and yesterday it closed with 27.79. So I actually understand that's 11 points. So that's a big move in a few days.

Patrick: Yeah. Well, I saw an article from Bespoke that was talking about, this three-day spike or these three-day spikes have been happening more and more since the financial crisis. It seems like markets have become more sensitive to this volatility. Can you point to any reason why?

Adam Warner: I don't know. I ran into that chart today, that I was looking at incidents with the VIX combined 40% past its enabling average and I have 23 incidents of it. But all but five of them are since 2010. So it really opposes the financial crisis phenomenon to see rows like this that often. I don't know, I guess, everything in the world reacts faster now, news reacts faster, people react faster to news, algorithms or whatnot. So that's probably the best explanation is just, volume is bigger, the traders are faster and it just moves more and it moves quicker. In a sense maybe it stops the moves a little sooner than they were. I'm just speculating here, but maybe marketing moves that might've taken a few weeks [07:10 inaudible]. I don't know the answer, but I think that's the reason I think it's just basket markets.

Patrick: Feels like, you look at all the pace of play statistics in something like basketball when you compare it to the eighties to now, where there's analytics involved, everything is quicker. The pace is quicker. I think it's just a product of technology, the internet. It feels almost cheating to say an answer to that simple, but I feel like that's all we got.

Adam Warner: Yeah. Like, I mean, I don't think the rapid traders do this.

Patrick: Yeah that's true.

Adam Warner: You know, maybe on the margin, you know, like there's no way that's the class now. This is all the goodbye that have kind of pull on like something this big.

Patrick: So you mentioned the 10-day moving average and that's a moving average we at Schaeffers track often even just for broad equities. Why the 10 though, you know, because there are other moving averages to use, shorter ones, like 20 and 40 and then kind of intermediate 80,100 and then the longer-term 200, 320, and then you can get into the weekly. What makes you hone in on like the 10 days.

Adam Warner: Yeah, honestly, I probably first read it from Bernie Schaeffer's report. That's probably where I started looking at it. I'm not for stocks because it looked more like 50s and 200s, but I think for something like this, statistic, I like the idea of just looking at it versus itself. I think like 10 day, that two weeks really, and that's the recent history of it and I kind of just think it's better, you're looking for just kind of outlier moves and I think he really needs to go short term to try and pick up that outlier. I think when we go, you know, firstly, that's a long time for just a statistic and it's kind of ancient history, I prefer a shorter term one for something like this. I'm sure there's utility, looking at longer ones, you know, for just a longer-term picture of it.  I think retreating in this particular case, the shorter term is better.

Patrick: For the VIX. I think for other, if you're looking at an individual stock, I think 10 day can be a little hairy sometimes, but when you're talking about like a volatility tool like this the shorter term, the better. 

Adam Warner: If a stock, you're going to get a lot of noise, obviously the shorter term look, which, is fine if you're going to be day trading and or whatever, if you're looking longer term it's [10:05 inaudible]. But if you're looking at the VIX as an indicator, I think you kind of want the noise because I think you'd always define the noise and Hey, there's too much noise and maybe that's contrary. So maybe that's a feature, not a bug,

Patrick: So that leads into my question. There is, what are some ways a retail trader or a retail investor can take advantage of VIX spikes or even on the other end, like kind of like a muted VIX. Can they profit are off it? Can they use it as an indicator? What can they do?

Adam Warner: The VIX, I'm going up too [10:48inaudible] fast. Generally speaking as a big country indicator like these, they mentioned these times has gone 40% above. A week later, it's up about two thirds of the time. And two to three week later it's about the same thing. There are a couple of major accidents, mostly last year. VIX went 40% above on the way to just exploding and the market last February and March, you know, I'm sure people never get destroyed. Crashes come from oversold markets that come off of like overboard markets. It doesn't crash from the top really, it crashes after it's already started declining. 

So the same thing with this, an overboard VIX tends to show moves over extended, but there some real disasters in that. So generally speaking, I think you can fade in or buy the market, not by the VIX. You could buy the market into an overboard VIX. The reverse is not really true. Like if the VIX is weak, it tends to be weak slowly. You know, like today it's down a lot. It'll go down a lot off the top, but I think we're talking more about, you know, just like drifting, like from all this year, this year being 2021, you know, it's drifted into the teams, that's just, apathy isn't really a great market signal. It's just kind of apathy and that I would not use any kind of VIX analysis in any major way.

Patrick:Yeah. Well, I pulled our episode from late February. I think it was the 25th and we talked about the volatility crush and the VIX had just dipped below 20. Since then it had spent a considerable amount of time below 20. In reality, we didn't really have much to talk about then because it was so muted. Now I think it's the time to highlight its utility.

Adam Warner: Right, exactly. That's, that's more normal. Just the kind of like constant drift, you know, usually places a little higher than the actual market volatility. So generally speaking, it anticipates that the market will get a little busier and most of the time it doesn't, and then you get the [inaudible 13:11]. This is really kind of typical, you know, drift, drift, drift, then explodes in a week. And then, you know, I'm going to give you a prediction, you know, maybe the market stopped and [13:24 inaudible] but these are most likely blips and in a few weeks or months over back to drifting. On top of that you have summer coming up, which almost always tends to be a slow time. So if I had to make a grand prediction, this is a blip. And, you know, maybe in the flaw you'll start to see, you know, more of a sustained lift in the next [13:49 inaudible]. That's what I tell them.

Patrick: Because I think that's important to say, because you're right, you don't want to make any predictions, but you can still say without predicting that we shouldn't overreact you know, this inflation data has been coming out for a while now, it's nothing new. There as been no new developments, really. It just kind of all bubbled over. And what happens when something bubbles over it goes back down to normal.

Adam Warner: Yeah. That's right, inflation is a good example. It sounded like you said, it has been on a radar and then you have a couple of data points, this week that if you're of the belief that inflation is gonna be a problem, it certainly [14:29 inaudible] that. And yeah markets get spooked, but a few weeks maybe a data points, you know, either it's not as bad as we thought or people just get used to pricing it in, and then you've got Memorial Day weekend and you got summer coming up and then it tends to dampen volatility, and tends to market groves.

Patrick: We talked about it in the intro. You have the CDC announcing that anyone with two shots, you know, can basically resume to life as normal. Retail sales are coming out tomorrow. That sentiment can kind of start to pull it back down to the levels it was in the early spring. But I do think it's important for retail investors to kind of have that information in the back of their head for when it spikes, how to kind of react. So I guess kind of really the last question is, whenever the next spike is, how should an investor react? Like, should they consider hedging? I mean, I don't want you to give advice, but just walk me through what their mindset should be.

Adam Warner: Yeah. I tend to like to go a little long into VIX spikes, but again, I would emphasize it works more than a dozen, but the accidents are brutal. So you do have to have an eye for the door that, Hey, maybe this is a really bad at timing. My dad used to tell me this, only buy as much that lets you buy more, you know, if it goes lower, like don't shoot your whole backend power in one shot. So buy gingerly, or go long gingerly into these spikes and if you're wrong start cutting back and then take your loss.

Patrick: Yeah. So basically what you're saying is don't overpay for like a lifetime contract for Bobby Bonia?

Adam Warner: Right. You might find yourself paying a million dollars every year until like 2050.

Patrick: That still blows my mind. 

Adam Warner: I think Bobby Bonia is kind of [16:49 inaudible].

Patrick:  Yeah. Is this the final year?

Adam Warner: No, I don't think so. I think it still goes.

Patrick: Wow. That's amazing. I mean, I just wanted to have you on here for a quick episode. But thanks again for coming on Adam. Best of luck to the Knicks in the playoffs, the Celtics, I don't know. I might have to kind of temporarily shift my fandom, no let me clarify that. I'm not shifting my fandom. I will be rooting for the Knicks to cause some problems.

Adam Warner: Are you a Red Sox fan?

Patrick: They are great but the problem is living in Cincinnati. I only get to see them every now and then on ESPN plus. You see Disney buy-in LA Liga and the Buddha's league, why can't they just grab the MLB too. Put it all under Mickey Mouse's umbrella. Red Sox fans are all over the place and it's harder to watch, but Hey, I'm going to get off my soap box now. Thanks again for coming on Adam. We'd love to have you on again and go Nets and Knicks. I can't believe I just said that. 

Adam: Thanks for having me on Patrick.


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