More on the VIX at Seven-Year Lows

This is a follow up to Examining the VIX at Seven-Year Lows from the always sharp-witted Adam Warner.

Adam noted that Friday the VIX closed under 11 for the first time in 7+ years, but that such a low VIX isn’t by itself a reason to fear the VIX rising. From Adam…

“…there’s nothing terribly significant about busting through absolute numbers. And there’s especially nothing particularly tradable when those absolute numbers are violated on the downside. The market actually tended to outperform three months out after VIX busted below 12. That’s not to say VIX going lower is bullish. Rather, it says that low VIX is a byproduct of a strong market, and long-term trends tend to stay in motion.”

To confirm, below I’ve shown the annualized return of the S&P 500 (VFINX), in the 1-month (blue) and 3-months (red) following a VIX close below X, since 07/1986. For comparison, the dotted line represents the annual return of all days.

20140610.01

It would of course be much more relevant to show VIX futures/ETP returns, but that data only extends back to 2004. Because VIX futures/ETP returns are so well inversely correlated with equity returns though, we can (more or less) assume a rising market would have been good/bad for XIV/VXX.

The graph confirms Adam’s point that a low VIX is not by itself a reason to fear (note the strong average market performance following low VIX readings). There are all sorts of tools and indicators we can use to guide our VIX trades, a low VIX just isn’t one of them.

Of course, eventually, this will all be very wrong and the VIX will spike once again, but “eventually” could be anywhere from today to a long, long time from now. From Adam again…

“Again, VIX itself is at more than seven-year lows, so it’s tough to argue with the urge to pay a premium for VIX futures. It’s just that this is far from the only time the market has felt this way … it always feels this way. So, why should this time turn out any differently? The answer is it will turn out differently someday, there’s just no reason this is THE time.”

Good Trading,
Volatility Made Simple

Wonk note: for all dates prior to 1990, I used the VXO index in place of the VIX index.

Posted in Real-Time Analysis.