Wednesday, November 2, 2016

VIX Median Reversion and Five-Year Moving Averages

When people talk about the VIX you often hear them refer to mean reversion, which refers to the tendency of the VIX to be pulled inexorably in the direction of its long-term mean.  With 27 years of data from the CBOE (including some historically reconstructed data), it is possible to calculate the lifetime VIX mean, which happens to be 19.71 at the present.

As an options trader, however, I am wary of giving too much weight to outliers when it comes to predicting the most likely outcome in another options expiration cycle or two.  For this reason, I am more interested in knowing the lifetime VIX median, which is only 17.84.  The median is the 50th percentile while the mean just happens to be in the 60th percentile.  The discrepancy is due to the fact that VIX values are not normally distributed.  Instead, VIX values exhibit a positive skew (a topic for a future post), due to the fact that there are a handful of VIX historical extremes in the 50s, 60s, 70s and 80s.  Meanwhile, the middle 50% of VIX values (the 25th to 75th percentiles) range from 14.04 to 23.98.

So…if the VIX median is so important, why is it that we never hear about it or about median reversion?  Good question.  I touched on that subject on “Drilling Down on VIX Mean Reversion” in the January 2013 issue of Expiring Monthly:  The Option Traders Journal.  As I see it, anyone who is focusing on means in a skewed distribution is necessarily assuming a normal distribution and statistics related to normal distributions when no such distribution or relevant statistical analysis exists.

I mention all of this because yesterday was one of those periodic bursts of activity for me on Twitter.  In some Twitter conversations, we discussed the median VIX vs. the mean VIX and there was a request for a chart of a five-year moving average of the median VIX.  Since I have never seen such a chart – or any VIX median chart for that matter – I present below a chart of the five-year moving average of the median VIX, using data going back to 1990. 



 [source(s):  VIX and More, CBOE]

Note that the current five-year median VIX is 15.07, while the five-year mean VIX is 16.63.  For the full history of the VIX, going back to 1990, the lifetime median VIX is 17.84, 9.5% below the lifetime mean VIX of 19.71.  What does all this mean?  Mostly that one should be careful using statistics that are associated with a normal distribution when analyzing the VIX.  Perhaps more importantly, VIX traders should also think at least as much about median reversion as mean reversion.

As an aside, while I have not been active on the VIX and More blog as of late (this is about to change soon, starting today), I have been active in various other media incarnations.  Last Friday, for instance, I was a guest on the Volatility Views weekly podcast hosted by Mark Longo of The Options Insider.  Tomorrow at 2:00 ET, I will be a speaker on a webinar, Trading VIX to Hedge Market Risks: What You Need to Know, with Tom Lydon of ETF Trends, Greg King of REX Shares and Vinit Srivastava of S&P Dow Jones Indices.  On the print side, this Saturday I will also be a guest columnist at Barron’s, pinch hitting for Steve Sears.  Last but not least, if you wish to follow me on Twitter, where I have been active for ten (!) years, you can find me at @VIXandMore.

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Disclosure(s): the CBOE is an advertiser on VIX and More

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