Friday, July 27, 2007

The Return of the Absolute VIX

When I started this blog, back in January of this year, it was widely accepted that volatility had died, crushed by the weight of an ocean of global liquidity. At the time, the VIX numbers had lost most of the meaning they once held. Always a resilient bunch, traders tried to compensate for the low volatility readings, first by declaring that 12 was the new 15, then 10 was the new 12, and finally capitulating by insisting that the VIX had outlived its usefulness. In a nutshell, that is how we made it to February 27th awash in complacency.

Bloggers were all over the story of the dead VIX. Ron Sen at Technically Speaking noted the prevailing sentiment about a terminally ill VIX as far back as November 2005. Even after the February 27th VIX melt up, MissTrade declared that the VIX corpse was “still dead.”

Fast forward to the present and here we are with a VIX in the 20s and suddenly the old numbers may have some meaning. Now 15 looks like the new 10 and it makes sense to talk about the absolute levels of the VIX, not just the VIX numbers relative to some moving average of recent values. Not only that, but it is time to consider mean reversion in the context of a VIX with a lifetime mean of 18.94. In looking at the chart below, one of the first things you notice is that whenever the VIX lives below its lifetime mean (the dotted blue line), the SPX is in a bullish phase, but when the VIX rises above the lifetime mean, the odds of a SPX bull drop back to no more than 50-50.

I will have a lot more to say about the absolute level of the VIX in the future. For now, I mostly want to stretch the historical context of the VIX back to encompass the full 17 ½ years of VIX data.


1 comments:

Brian said...

Bill,

I like this chart. Good work.

I'm looking at the period from the end of 2006 to now, and comparing it to the end of 1993, into 1994. After the spike above the mean in early '94, the VIX settled down for another 2 years. What will happen here? This is the third year in the presidential cycle, which is typically bullish. I think the fear this week was way overblown. We should have a decent bounce coming up in the near term.

The long term has been my fear for awhile. I think things will get very difficult going forward. But not until 2009. We shall see.

Brian

Brian

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