From the looks of some of the Google searches that have been attracting readers to the blog today, it appears that a sub-20 VIX that is more than 10% below the VIX’s 10 day simple moving average has a lot of people wondering about overbought signals.
- Focus on the relative values of the VIX (i.e., with respect to a recent trading range) instead of absolute values
- Consider the cash VIX in the context of expectations for future volatility
- The more extreme readings give more reliable signals
- History favors mean reversion for the VIX
- Mean reversion does not always happen quickly, so scale in to a position
- If you follow good risk control, VIX signals are one of the few ones for which it is acceptable to add to losing positions (assuming the mean reversion signal is still valid)
- Be sure to start taking profits in no more than 1-2 weeks
So…that is my thinking. A sub-20 VIX? Not really relevant. A VIX more than 10% below the 10 day SMA? Generally tradeable. A better signal? While it is still too early ‘cling tightly’ to the VXV (an index that calculates the 93 day implied volatility for the SPX options), I am bullish on the VIX:VXV ratio – and the chart of that ratio suggests that the market is approaching an overbought condition.