When It Comes to VIX, What is 'Normal'?

The CBOE Volatility Index (VIX) could suggest we're in a transitional phase

by Adam Warner

Published on Feb 2, 2015 at 9:09 AM
Updated on Apr 20, 2015 at 5:32 PM

Another week, another CBOE Volatility Index (VIX) PANIC ATTACK! But yet it's not really a panic. The market is so prone to bigger ranges and reversals and plus-1% drops nowadays, it's tough to call it unwarranted. In fact, it's downright sane.

VIX closed at about 21 last week, but yet did not register an "official" overbought signal yet. It closed Friday 13% above its 10-day simple moving average (SMA). Let's call it "elevated but orderly."

I saw some pundit on TV saying the VIX at 20 is merely a return to "normal" … and then I proceeded to spit out my coffee … and also send out about 10 tweets. It's tough to make a point in 140-character bursts, though, so let me clarify a bit.

"Normal" and "long-term average" are two different animals. My database goes back to 1993. And yes, the mean of VIX is 20.11. VIX was lower in the early 90's, so the all-time mean is almost exactly 20.

But that does not mean VIX is "normal" at 20, and in some sort of disequilibrium state when it's not. For one thing, median would be a better test of "normal," and the median back to 1993 is 18.46. My friend Bill Luby of VIX and More informs me that the all-time median is 18.11. So on this basis, 20 is actually high. In fact, back to 1993, VIX has closed at 20 or higher only 43% of the time.

More importantly though, "normal" is a silly construct to begin with. It's the same as saying 60 degrees is a "normal" temperature in New Jersey. If it is 45 degrees out tomorrow, does that mean it's below normal? Of course not, it's winter.

VIX goes through the equivalent of seasons. If we call the last four years "VIX Winter," then 20 VIX is seasonably mild. If we call 2008-2010 "VIX Summer," then 20 VIX is a cold spell. So even though 20 VIX is the long-term average, it's rarely "normal." The better question is: what does 20 VIX mean right here right now?

It sure feels like we're in a transitional phase. Here's the graph I ran last week that shows the median VIX from each calendar year back to 1993 (click chart to enlarge):

Average VIX level from 1993 - Present

We're certainly going to see a higher median this year, but 20 might still end up looking above "normal." I'd guess 2016 is the year 20 VIX seems cheap, but we'll see.

VIX futures are probably the best proxy for market expectations, though it's important to note that they've missed "high" out in time over and over again. So what do they say now?

VIX Futures Term Structure Feb. 2014 - Sept. 2014

They say VIX is indeed fair here. Take away a little weekend-gap fear premium from Friday, and the market does expect to see VIX with a 20 full no matter how far you go out in time. So maybe this pundit stumbled on the right answer after all!

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

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