A couple weeks back, former Treasury Secretary Lawrence Summers said that the Fed was unlikely to tighten while the CBOE Volatility Index (VIX) was elevated. On the surface, it sounded kind of silly. I mean, Fed policy dictated by a volatility statistic?

But it sounds more plausible than meets the eye. Volatility, after all, moves generally inverse to the market itself. And, if the market itself has done poorly, the Fed won't tighten. I mean, it literally won't tighten, as per this study:

"[H]ere's the thing: the Fed's decisions are almost entirely dictated by the stock market.

"At least that's the analysis from the global markets research group at Deutsche Bank. Stuart Kirk, a Deutsche managing director, said the 'Fed bashers who say monetary policy is a slave to Wall Street" have a point, showing data to support that claim.' 

" … In over 20 years, the Fed has never hiked once with the market down year-over-year. 'By that logic, forget the dots,' said Kirk, referring to the 'dot plot' graph on which individual Fed members pin their expectations for rates. 'If the S&P 500 is below 1989 come December, expect another hold.'"

What's more, they found that the market tends to rally right before the Fed announcement, so much so that if all you did between 1994 and 2011 was go long for 24 hours into the Fed, you would have realized 80% of the market gains over that stretch. That's ... absurd.

Now, the Fed decision relative to the market does make some sense. No, I don't mean the Fed basing their call on market action. Rather, I mean that, in a way, it's looking at something similar. The stock market is something of a discounting mechanism for future economic growth and trends. So, if the market has acted poorly looking backward, it suggests the economy doesn't look so hot going forward. Or, at least the perception is that the economy won't do well. Of course, we know that's not always the case; the market isn't always the best discounter of information. But, it does represent a prediction going forward.

The Fed is hypothetically doing something similar: It's projecting economic trends going forward and basing policy decisions on those trends. Thus, it is possible that this data really just reflects a logical coincidence, and that it's not really a coincidence, but rather two entities incorporating similar information and reaching similar conclusions. Or "The Fed's just managing and manipulating stock prices!" That's more fun to keep tweeting, and I'm sure someone somewhere is using this data as evidence for that thesis.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

The more things change, the more they stay the same. We had another ugly day yesterday thanks to (pick one):

1. Volkswagen
2. China
3. The Fed
4. All of the above
5. None of the above

I'll answer that: it's either A or B, though I have no idea. We do seem to really hate the Fed's decision not to hike. TV tells me it's because the Fed missed their opportunity to hike. I'm not sure that makes any sense, though. If they now won't be able to hike in October or December then ... well, what was the purpose of hiking now in the first place? Would hiking now have made those later hikes an achievable goal? In a related story, why is that a desired goal?

But I'm kind of rambling, I don't think any of that explains the market action. It seems more likely that we had basically discounted no hikes, and now we're in a sort of "sell the news" phase. Remember all the way back to last week, we had actually done quite well (relatively speaking) heading into the news. I can't prove it, but I'd guess that a hike would have surprised the market and we'd have sold off anyway.

Regardless, we're back in a range like we were in for most of the first (almost) eight months of 2015. The only difference is we're a bit more volatile within that range. The CBOE Volatility Index (VIX) in the low-to-mid-20s suggests we'll see ranges of about 1.5% in two-thirds of trading days. The flip side is that one-third of the days should see moves greater than that. VIX was in the mid-teens ahead of the August drop, so it at least suggests we're now more cushioned for moves like we saw yesterday.

By and large, we seem closer to a new equilibrium. VIX futures expect a low-20s VIX out as far as the eye can see.

The CNN Fear and Greed index is one big "eh": 

 We were down around 5 in there last month. As far as individual stocks go ... well, the majority sit in "bear" markets, if you define that as trading below their 200-day simple moving average.

We bottomed (so far) with about 20% still above their 200-day moving average, and that measure has rallied up to about 30%. If we're in a muted replay of 2011, we probably still have another month or so before this sort of measure turns around. We remain somewhat complacently ugly overall. Perhaps we need something more outright ugly and over-bearish before we make a more important turn.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

When it comes to quoting market moves, what makes more sense: percentage moves or absolute moves? It's pretty clearly percentage moves. I mean, the '87 Crash was a drop of 508 Dow Jones Industrial Average (DJIA) points -- which sounds pretty pedestrian in those terms by today's standards, where the same point drop would equate to 3%. In 1987, though, it wiped out 22.6% of the market's value in one day.

It doesn't have to be a crash, though, to make percentages preferable. "A drop of 1%" better contextualizes an S&P 500 Index (SPX) move than "a drop of 19.5 points."

But none of that is necessarily true when it comes to CBOE Volatility Index (VIX). I generally analyze and express VIX moves in percentage terms, but at times it makes more sense to use absolute terms. If VIX is very low, for example, percentage terms exaggerate and generally misrepresent the significance of moves.

Say VIX goes from 10 to 11. That's 10%! It sounds like a lot. It's also 1 point, and that sounds more like a rounding error. That's especially so when you consider VIX is simply a calculation and it's subject to quirks around days of the week, holidays, and the time of year in general.

The effect of using percentages instead of absolute moves mutes as VIX gets higher, but it's still a factor and can lead to fuzzy conclusions. I also believe absolute terms are preferable when comparing implied and realized volatility.

Ten-day realized volatility (RV) is a somewhat noisy number, and it can get very low at times. You might see cases where it's something like 8, while VIX is 12. If you use percentage terms, then we'd say implied volatility (VIX) is 50% above 10-day RV! It sounds fat… and it's very misleading. It's way better to compare the two in absolute terms. In this case, implied vol is at a 4-point premium to realized vol, which is… historically very normal.

On the other hand, we shouldn't disregard percentages. Take the recent VIX pop over the past month. To me, expressing it in percentage terms made perfect sense. VIX moving from 15 to 25 is indeed more significant than, say, VIX moving from 40 to 50 (which we did actually see intraday). Why is that?

Well, VIX translates to a standard deviation, and we can translate that to a percentage move in an underlying index that is factored into the options prices. Thus, if VIX doubles, it essentially doubles the "coverage" of an SPX move. Think of the guy who sold options into a VIX pop. He's not hurting theoretically* until the stock move or range exceeds the implied vol he got for his options.

(*I say theoretically because implied vol moves too. Maybe stocks themselves are contained, but if implied vol explodes in his face, that's also painful.)

My point is that from this angle, it's the percentage move in VIX that's more important, not the absolute move. All in all, though, we need to incorporate both absolute and percentage moves into our analysis. There are pluses and minuses to each approach, and the last thing you want to do is ignore one of them.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

By now you've probably heard the biotech story: Hedge fund guy jacks up the price of some relatively obscure drug 5 billion percent; Hillary Clinton proposes price caps; entire group gets pounded.

Oh, and implied volatility (IV) in the whole group is souring on a relative basis. This, from Bloomberg:  

"Implied volatility on an exchange-traded fund tracking biotechnology companies is at its highest in 16 months versus an ETF that mirrors a broader universe of health companies including insurers and hospitals.

… Clinton's tweet sent traders scrambling to protect against price swings in biotech just as the industry was starting to regain its footing following the late August correction in U.S. stocks. The iShares Nasdaq Biotech ETF has dropped 7.5 percent this week. It lost 0.9 percent at 9:40 a.m. in New York and is on pace for its fifth straight decline. Meanwhile, the broader S&P 500 Health Care Index is down only 3.1 percent since Monday." 

OK, if there was ever a sign of a jittery market, this is it. Hillary has more or less a 50% chance to be our next president. Whomever we elect, they're not starting for 16 months, so already we're talking about something reasonably far in the future and well beyond where the market tends to focus.  And if it's Hillary, there's about 0% chance this cap ever happens. 

Yes, it's now going to briefly turn into an issue, and the jawboning has already had modest impact. But again, there's no chance anything ever passes on this front. And in the interest of equality, I'll add that nothing Trump proposes is going to happen either.  

And yet, the iShares NASDAQ Biotechnology ETF (NASDAQ:IBB) gets slammed and they come running for IBB puts. It's yet another reason to get scared out of stocks. Remember Greece? That was like 27 crises ago now.

The irony of this biotech volatility rush is that it's not particularly justified in the backdrop of actual IBB vol. Even after this week's ugliness, 10-day realized vol (RV) in IBB is about 30, down from a peak of 54 on Sept. 2. What's more, it's actually drifting lower. It was as high as 40 on Monday. Meanwhile, the IBB "VIX" is 37. That's down from a peak of 43.5 on Aug. 25, but up from a recent low of 30 last week. 

Yes, RV lags while IV anticipates. But the news is out already (sort of). The big reaction drop is now in the rearview. Obviously anything can happen going forward, but at this juncture, IBB looks no uglier than the rather ugly market as a whole. So I'm not sure there's any reason to bid vol up here on a relative basis. 

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

The stock market has been extremely volatile over the past month, with most of the action to the downside. So, how is this impacting sentiment among institutional investors? As you might've guessed, it's forcing them to the sidelines.

Specifically, the latest National Association of Active Investment Managers (NAAIM) Exposure Index number came in at 21.3 -- roughly 10 points below where it was one week ago. This is also the 10th time the reading has dropped at least 10 points, week-over-week, in 2015. To put that number further in perspective, a response of 100 indicates an active money manager is full invested, while a negative 100 reading indicates one is fully short. The average NAAIM number since 2012 is 70.8 -- quite a bit higher than where it is now.

Also worth noting, the 10-week moving average for the NAAIM reading is 38.7%. As you can tell on the chart above, that's the lowest level since December 2011. This is a relatively rare occurrence, too. In fact, since 2008, the 10-week moving average has registered south of 40% just five times.

With the help of Schaeffer's Quantitative Analyst Chris Prybal, I decided to look at what that rare signal could mean for the S&P 500 Index (SPX) and CBOE Volatility Index (VIX). As you can see below, SPX returns tend to be quite bad -- averaging a 10-day post-signal loss of 0.8% versus an anytime return of 0.2%. Going out to 63 days (roughly three months), the average loss hits 3.6% -- exacerbated by a brutal stretch following the July 2008 signal -- compared to an anytime return of 1.8%.

Meanwhile, VIX returns tend to be higher than usual after the NAAIM 10-week moving average breaches 40%. The average 10-day and 63-day returns are 1.5% and 25.8%, respectively, versus anytime returns of 1.7% and 5.1%.

Another Friday, another sell-fest. At least this one waited until the last hour. Pretty discouraging stuff all around. What we really need is extreme sentiment on the bearish side to turn things around for real. Anecdotally, it feels over-bearish. In reality? There are some extremes, but plenty of pretty mediocre numbers out there.

Bullish bets on the CBOE Volatility Index (VIX) hit relative records, as we recently noted, and that's good from a contra-tell side. The problem is that the VIX board is always tilted that way. And it's also apparently more a function of bearish bets in VIX ... or, rather, lack thereof. No one has much interest in casually getting in front of a somewhat slow-moving freight train.

And VIX itself isn't doing much lately. Twenty-two is modestly high, but very much in line with current market volatility. The VIX futures don't expect a whole lot going forward.

The slope looks big only because a small differential covers the whole graph. It only dips down to just below 21 around Christmas/New Years; otherwise, its mid-21s almost the whole way around. Very eh.

How about options? I'm not big on put/call numbers, or call/put for that matter. But hey, if you see a big rush to puts at the same time there's a VIX-plosion, at least it's a reinforcing data point. So what about now, with not a lot of VIX action? Here's the International Securities Exchange Sentiment Index (ISEE), which is a call/put measure:

ISEE only "counts" opening public transactions, so it's a proxy for the smaller player, presumably. It's on the low end, so there's a slide toward puts. But given the general ugliness around, I wouldn't call this much more than consistent with the overall trend. So, not much here either.

Well, here's one data point that suggests it's a little too bearish. This, from Bloomberg:

"Bears are winning out when it comes to daily U.S. stock trading.

"Volume on days when the Standard & Poor's 500 Index falls has been 27 percent heavier than the up days this month. That's about eight times the average gap in the past decade, data compiled by Bloomberg and Bespoke Investment Group LLC show.

"The volume disparity highlights the risk of more losses for investors who have been whipsawed in a market where stocks have alternated between gains and losses for 10 weeks. The S&P 500 has slipped back to within 3.5 percent of its August bottom, with a third of its constituents already breaking below those lows."

Bears are indeed "winning." But I'd suggest this actually bodes well going forward. Someone's unloading the boat on these ugly days, and will perhaps have to scramble and play catch up if we ever rally again for more than an hour.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

You probably don't need me telling you that fading an overbought CBOE Volatility Index (VIX) hasn't worked out so well in the last few months. But in case you do, let me reiterate that fading overbought VIX has worked out quite poorly.

Here's ye olde updated table looking at instances where VIX closed 20% above its 10-day simple moving average, and the ensuing one-month and three-month market moves, as well as the market move until VIX closed back below its 10-day.

 

If it feels like a rerun of 2011, that's because so far it's very, very similar. We got overbought in VIX in late July… and then the market really got ugly. In 2011 it was in early August, this go-around it was a couple weeks later.

The good news? We re-tested unsuccessfully in 2011. The SPDR S&P 500 ETF Trust (SPY) made a lower low on Oct. 3, but then ultimately rallied off that. The timing is very similar to our current re-dipping here.

The bad news? VIX made new closing highs in October 2011, when the market hit new lows. This go-around VIX isn't getting quite as panic stricken. But hey, we do have an interesting similarity.

VIX, as we know, is quite responsive to changes in SPY, albeit in reverse. Hence the Volatility as an Asset Class Industrial Complex. Over time, VIX typically moves about negative-6x the move in SPY, though "normal" in that number does fluctuate. We typically see VIX moving more exponentially as SPY gets hit. But that's not really what we're seeing now. Here's a look at the 2015 20-day trailing best-fit VIX percentage move "line" relative to the SPY move. Remember, this is a negative relationship, so lower on the graph means VIX is reacting more to SPY.

 

This ratio peaked in late July, during a "minor" VIX blast, and has actually trended way down, save for a blip in the August VIX-plosion. For what it's worth, the behavior was pretty similar in 2011.

 

What's it mean? I'm not real sure.

I'd suggest it's a sign that markets overreact less and less as sell-offs get longer in the tooth. Normally I'd say it's time to panic at the lack of VIX Panic. But perhaps it's a sign that the worst is over? Guess we'll soon find out.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research. 

Way back in the dark ages of finance -- the '80s -- there was a market crash. There was no Twitter to sarcastically comment on it ... or brag about how short you got right before everything imploded. There was no Instagram to show what you were eating while the market crashed. There wasn't even an Internet, unless you were a scientist of something. There were no CBOE Volatility Index (VIX) calls to race into. In fact, there was no VIX -- any numbers you see from 1987 are backdated calculations.

But there were designated scapegoats. That hasn't changed much over the years. One scapegoat was stock index futures. The pre-algos of the day would execute trading programs in the futures as an arbitrage play. It provided an easy way to buy and sell "the market" at once. The second scapegoat was portfolio insurance.

"Portfolio insurance is an investment strategy where various financial instruments such as equities and debts and derivatives are combined in such a way that degradation of portfolio value is protected. It is a dynamic hedging strategy which uses stock index futures. It implies buying and selling securities periodically in order to maintain limit of the portfolio value. The working of portfolio insurance is akin to buying an index put option, and can also be done by using listed index options."

The idea sounded great, until the market started tanking -- at which point, portfolio insurance required even more selling. The increasingly popular futures were the most liquid and easiest way to "insure" the portfolio. That brought in the program traders buying futures at steeper and steeper discounts and hitting every stock bid they could as part of the arb. It all snowballed into a debacle.

I bring this up because we're in the midst of some serious ugliness -- and, of course, we need a scapegoat. And lately I keep hearing the scapegoat is exchange-traded funds (ETFs).

Like futures 28 years ago, ETFs can add to volatility. When times are rough, it's pretty common to just hit the figurative "button" to sell something quickly, then maybe sort out the details later. And as ETFs become a bigger and bigger part of the market, it stands to reason they can have a bigger and bigger impact.

But as a cause of all this? Please.

They add to correlation by the mere fact that stocks in a popular index will correlate a bit more as the ETF itself gets more popular. A basket trade will just trade them all in one nanosecond. And correlation is akin to volatility, as far as the index is concerned.

But ETFs are long in the tooth at this point. The SPDR S&P 500 ETF Trust (SPY) came out in 1993, just to name one. Lots of the popular sector ETFs, like current "poster child for volatility" iShares NASDAQ Biotechnology Index ETF (NASDAQ:IBB), came out in the '90s. Some flopped. Remember the B2B sector? The ETF was huge in the late '90s, now I can't remember the symbol offhand. Many have just grown and grown. And the overall growth of the industry has been pretty persistent over the course of time.

And yet, market volatility has not trended higher over the course of time. If the preponderance of ETFs literally caused volatility, then I'd expect to see at least some sort of relationship between ETFs as a share of the marketplace and index vol. Yet, I haven't seen one.

I do believe ETFs can add to vol on the margins. Again, it's going to add to correlation, and correlation equals vol. Perhaps they contain volatility at other times. I don't really know. I do know that there's no particular, concrete reason to blame them for the current market woes.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

Volatility: It's not just for us mere mortals.

"They may have money to lose, but, like any other investor, they hate to lose it ... High-net-worth individuals (HNIs), who continue to have a high degree of exposure to the equity market, are feeling the pinch from the current bout of global market volatility, with both direct equity holdings and indirect holdings through hedge funds, taking a beating."

Sounds like all of us. Except there's one large difference:

"What could possibly make things a little worse for HNIs is the fact that many of them tend to invest on credit. According to the Capgemini-RBC Wealth report quoted above, 18% of all HNI assets are financed through credit. And 40% of credit taken is being used for investments, showed the report."

Well, maybe that's actually not such a large difference. People do still use margin to play the markets when last I checked.

Let me make one thing clear, though. It's not "volatility," per se, that's rattling everyone here. It's "assets declining." Volatility is not a cause of assets declining in value. Rather, it's a byproduct.

We're all humans. Well, maybe the machines aren't humans, though somewhere down the line there's a human programming the machine, and feeling the financial impact of the trading and investing decisions from said machine. Unless, of course, "The Matrix" is a true story.

Setting that possibility aside, we humans hate losses. And we really hate the possibility of open-ended losses. So we take action to mitigate or prevent those losses. That's gibberish for "we sell into weakness." And the worse it looks, the more jittery we get. And so on. The volatility can and does feed upon itself.

The dynamics are obviously quite different in a rally. As a whole, we don't need to defend much of anything. Emotions are muted and volatility tends to wither.

The reason why "volatility" tends to take the blame for all this is that we do tend to see some volatile upside days in the midst of overall downtrends. Like ... yesterday. Perhaps it's a shakeout to the shorts; perhaps it's just many waiting for an uptick before they start buying, and then they get worried about being left out of the turn. Who knows? But that tends to dissipate somewhat rapidly.

But make no mistake, it's the ugliness of the markets that's causing a bit of a freak-out. It causes the volatility, not the other way around.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

Well, we officially have our first high-profile wrecked hedge fund story of the 2015 correction (or bear market ... we'll see). Via The New York Times:

"It was an upstart hedge fund that pitched large returns in periods of market turbulence by relying on a complex and controversial trading strategy.

"At the height of the 2008 financial crisis, investors would have had a gain of more than 600 percent, according to projections in investor documents for the new hedge fund, Spruce Alpha.

"But when markets again turned volatile this August, Spruce Alpha, which had started in April 2014, failed to turn the turmoil to its advantage. For that month -- a particularly difficult period for many money managers -- Spruce Alpha fared worse than most, losing investors 48 percent of their money, according to documents reviewed by The New York Times."

What was the controversial strategy? They don't say. But there are a couple of clues.

For one, they refer to exchange-traded funds (ETFs), and the seizing up thereof on Aug. 24. For another, they refer to leverage and the fact that said ETFs are really only designed for one-day performance. So, I'm going to put two and two together and say the strategy played with leveraged ETFs.

Which leveraged ETFs? Well, the person briefed on the Spruce Alpha fund said the August losses were the result of unprecedented upheaval in the CBOE Volatility (VIX), an index that measures volatility in the market.

Ok, then. Sounds like we're talking about the VelocityShares Daily 2X VIX Short-Term ETN (TVIX), and/or the ProShares Trust Ultra VIX Short-Term Futures ETF (UVXY), and/or the ProShares Short VIX Short-Term Futures ETF (SVXY).

Even though the VIX didn't make a historic move in terms of points or actual percentages, it did make a historic move as measured by the speed of the move as quantified in percentage terms. So, yes, I can see where someone on the wrong side of it maybe got drilled.

But here's what's a bit of a mystery: How did a fund that billed itself as able to generate large returns in a period of turbulence do the diametric opposite? The alleged culprit isn't the volatility itself, but rather the fact that the volatility was multi-directional.

Let's say they only used UVXY and SVXY. Just to refresh, UVXY is two times the iPath S&P 500 VIX Short-Term Futures ETN (VXX), while SVXY is negative two times VXX. If they missed the start of the market drop, but then loaded up on UVXY at the close of Aug. 24, they would have done perfectly fine. It closed at $57.30 that day. It actually went even higher -- much higher, as it peaked at a closing high of $87.54 on Sept. 1. It then dropped, of course, but closed yesterday at $54.78, so it's a round-trip to nowhere so far.

They could have instead faded the move and bought SVXY on Aug. 24. That runs exactly counter to their stated objective of profiting/protecting during times of market turbulence. But, hey, what's a little "style drift" between friends and family?

Well, that side didn't do quite as well. But it's also not an absolute disaster. SVXY closed at $57.14 on Aug. 24, drifted as low as $41.63, and closed last Friday at $49.09. However, it's hard to believe they bought and held SVXY, since I'd like to think a fund is sophisticated enough to know not to buy and hold a leveraged tracker ETF.

There are indeed funds that short both sides of leveraged ETF "pairs" and try to play the compounding-attrition game. It's a de facto short gamma trade, and like a short gamma trade, it mostly works -- until it doesn't, in a big way.  

Again, they mention that what did Spruce Alpha in was the gyrations, not the one-directional move. That's exactly the opposite of what you'd see if you shorted both.

All I can guess is they flipped these pups with incredibly bad timing. And then, as losses mounted, they increased size to try to make it back -- and thereby compounded the losses. Frankly, not enough happened here, or in the market in general, to explain the asset implosion.  

And if that's the case -- well, you can blame leverage and ETFs, since that's what they presumably used as a trading vehicle. But it's more likely hubris and human nature, and someone doubling down a bad bet with someone else's money. The marketing based on outsized, back-tested returns is inherently dishonest. It's not tough to data-mine a strategy that worked in reverse. I'm guessing the leaked cause of the demise here is a bit misrepresented, as well.  

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

What if we had a CBOE Volatility Index (VIX) spike and nobody showed up? That's what seemed to happen last week, when VIX actually nudged into overbought territory on Monday, as Mr. Market made a lower low. And then a funny thing happened: We rallied. And then rallied some more. All told, the SPDR S&P 500 ETF (SPY) popped 1.1% on the week, which doesn't sound like a lot ... until you consider we started the week down 2.57%.

VIX closed the week down 11.1%, which in a vacuum sounds like a large move vs. what was ultimately just a 1.1% market pop. It sounds like an especially large VIX drop when you consider how we arrived at that net return; Friday alone had a 2.73% move.

On the other hand, the news is out.*

*Jobs number makes and misses are always misleadingly expressed, IMHO. The estimate was about 200K jobs created, while the actual was 142K, a miss of 58K. If you use a basis of 200K, then it missed by 29%, wow! If you use a basis of the 140 million or so jobs out there, it's more like a tiny rounding error. Throw in that the actual number is really an estimate adjusted for seasonality and many other things, and it really strikes me that it's kind of "whatever." As it almost always is, beat or miss. The trend is, of course, important, as are revisions to prior numbers. But that only serves to remind us that this number will itself get revised a couple times. But I really digress.

Were we really that nervous about this jobs report? I doubt it, though I suppose it's one data point out of the way and the market basically held the August lows so far.

Which brings us back to VIX. I count VIX as overbought when it closes 20% above its 10-day simple moving average. I declare it a separate incident once VIX has had a close back below its 10-day. I score SPY returns one month and three months out, as well as out until VIX closes below its 10-day. On average, that takes about 5.5 trading days. Anyway ...

We had some clusters of overbought VIX last year: three in a three-month period, achieved twice. That's a lot, considering it usually happens about three to four times a year.

Well guess what, we're even more clustered now. This was the fourth overbought VIX in three months. That sounds ominous -- although so far, so good. It took only three days to "correct," and it came with a 2.26% "win." Of course, that's coming off a disaster of a system trade. If you went long Aug. 20, you had to hold for nine trading days and saw a nasty 4.22% hit. If you're into 2011 analogs, that's easily the worst trade since an 11-day 7.22% scalping initiated July 29, 2011.

By and large, though, this trade tends to work, even including the recent accident. The median return is 0.99%, compared to a median return of 0.08% if you held for any random five-day period. As you can see by the chart, it mostly wins, or loses very small.

Future VIX seems to have settled into a bit of equilibrium:

December is a holiday month, and it tends to see VIX dip a bit. Thus it's a very flat term structure, thought it's interesting to see an upslope with VIX north of 20.

Not much has changed lately. Here's Friday alongside the term structure from 9/18 and 8/20. In both instances, VIX was in the 20-21 range. The first was right before the market drop.

Again, not much going on, relatively speaking. Ten-day historical vol is about 20, too, so it's tough to argue with the price of anything right now.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

OK, we've often talked about the positive side of an overbought CBOE Volatility Index (VIX). But what about the reverse -- the negative side of underbought VIX, in honor of breaking under 20?

Is 20 a key level? Well, it's the whole number that most closely approximates the all-time mean in VIX. And, hey, we're all about mean reversion here, so it has to mean something.

So here's the "system." We go long the market when VIX first closes below 20, after it has just spent at least three trading weeks closing above 20. We hold for one- and three-month time frames. How did we do? Well, take a look for yourself:

Recently, the trade has worked out well. The last four instances, going back to February 2010, the trade has performed quite admirably on the one-month time frame. And it did very well the last three instances, looking at the three-month time frame.

Going back further though, not so much. All in all, the one-month trade saw an average return of negative 0.87% in one month and negative 2.8% in three months, compared to returns of 0.65% and 2.01% in randomly timed one-month and three-month trades. Using medians instead of means didn't change the conclusions. I bring this up because it sets up again now, as we just broke below 20 after nearly seven weeks closing above.

So should you sell now? Maybe, but I wouldn't sell because of this. I find it interesting in principle that, by and large, a dip in vol to these levels after a period of "high" vol has looked more like an intermediate top than an all-clear signal.

But, realistically, I'm picking somewhat arbitrary numbers here. I used 20 because it's nice and round and pretty average for VIX, particularly psychologically. Most find VIX "cheap" under 20, even though that's not really the case. The VIX median back to 1993 is 18.26, so if nothing else, I'd use that as the "cheap" point.

And cheap isn't really that meaningful a concept in a vacuum. VIX is only cheap if it underprices future volatility. Fifteen may be fat if the next month sees realized vol of 10, for example. Since we don't know the future, we don't know whether VIX now is underpricing or overpricing future risk. That's all a long-winded way of saying I like using moving averages better, and putting VIX in the context of realized vol.

Bottom line is, it all comes down to whether you believe this was a blip within the longer-term bull, or whether it was the start of more of a down move. Since 2009, all of these VIX pops have been blips. That will end someday, but for now, we just can't say yet.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.