The VIX spikes up, but it rarely spikes down, today’s action notwithstanding. In fact, today’s 29.6% decline in the VIX is the largest single day decline in the 17 year history of the VIX and in the 20 years of reconstructed VIX data.
Using reconstructed data for VXO, which utilizes the original calculation methodology for the VIX, I find only one instance in the last 24 years in which the VIX declined more than it did today: Wednesday, October 21, 1987, two days after Black Monday, when the (original calculation) VIX fell 47% from 140 to just under 74. [For background information, try VXO Chart from 1987-1988 and Explanation of VIX vs. VXO for more information on VXO]
In thinking about the relative abundance of VIX spikes and scarcity of dramatic VIX drops over the course of history, I sometimes like to invoke the metaphor of a medieval castle. A dragon periodically appears and terrorizes the castle and its inhabitants, sometimes visible for only a fleeting moment and other times hanging around for an uncomfortably long period of time. Every time the dragon appears, the citizens panic. One day a knight goes out into the forest and slays the dragon, returning with the head of the beast. The citizens rejoice and relax for a moment, until it occurs to them that the forest may be filled with dozens of dragons.
So…one dead dragon does not mean the crisis has passed.
Getting back to statistics, the VIX has fallen 20% in one day on eight previous instances. On average, looking forward one day, week, month, quarter, etc., stocks have tended to underperform somewhat following a sharp drop in the VIX. The last two instances of 20% drops, from October 2008, have now skewed the data so that aggregate performance looks quite dreadful. Still, one can argue that in the first three of the eight instances (1993, 1994 and 2006), stocks outperformed historical averages when looking at least two months out. All things considered, small sample size and all, I would have to conclude that today’s action translates to a mildly bearish outlook going forward – at least based on historical data.
For more on related subjects, readers are encouraged to check out:
- VIX Drops 20% in One Day Again
- Yesterday’s VIX Drop is Fifth Largest Ever in Percentage Terms
- On the Rarity of a 20% One Day Drop in the VIX
- VXO Chart from 1987-1988 and Explanation of VIX vs. VXO
- Short-Term and Long-Term Implications of the 30% VIX Spike
Disclosure(s): short VIX at time of writing