Since the picture tells almost the whole story, I’ll add only a few supplemental comments:
I am fortunate that my dog, Logan, is a well-adjusted, happy-go-lucky, 1 ½-year-old canine. To put things in perspective, his idea of a bad day in the market is any time we come home from the grocery store without cheese."...my firm prefers the idea of buying “call options” on the Volatility Index (VIX) as an alternative to buying the QIDs, despite the fact that “longing” the VIX has proved to be a losing strategy over the past few months."
I looked at end of day price changes in the VIX covering a period of 10 days prior to the FOMC announcement to 10 days following the announcement, from 1990 to the present . I normalized the EOD VIX on announcement day at 100 to make for a more meaningful scale and the following picture jumped out at me:
The graphic tells the story rather succinctly and it suggests that it is wise to be short volatility on the day before the FOMC announce and to be long volatility the day after the announcement, with the expectation of a volatility mini-crush of sorts, on the order of about 3.5% -- with half of that move coming on announcement day and the other half of the move coming the day after the announcement.
It turns out that Peter Carr and Liuren Wu published some similar observations in May 2004, so I checked to see if the publication of that information resulted in a change in the trend. To my surprise, the trend has remained relatively intact in the subsequent 21 data points over the past 2 ½ years:
Looking at the more recent data, the mini-crush has been closer to 3.0% since May 2004, but two key differences should be noted:
Of course, there is considerable risk in jumping to conclusions that the 21 most recent data points are defining a new context for FOMC announcement volatility, but that possibility bears watching.
"...forget about where the VIX has been in years past, and instead focus on getting the most of out the VIX using relative bands like Bollinger Bands. You can see that when the market tagged these lower boundaries for the VIX, as in mid-December and mid-November, then the market is ready to correct or at least go sideways. This follow-up information will prove invaluable as a contrarian, being willing to sell the market when the VIX is at its lower band, while being able to get more aggressive when we see fear spikes to the upper band. "For the record, I am a strong believer in applying Bollinger Bands to the VIX and am of the opinion that Bollinger bands can provide solid trading setups not just for the broader markets, but for the VIX as well.
"A two-month drop of nearly 10% in the S&P 500 Index began at the end of January 1994. The emerging markets collapsed -- Hong Kong's market fell by a third and Mexico by an even greater amount. The bond market got schmeissed -- by year-end, the 10-year U.S. note had fallen 20 points, correcting the entire gain of the previous three years. Finally, the VIX fell back to 1990 levels, climbing from 9 to 24 in only two months..."Today's 13% rise in the VIX does not necessarily herald the beginning of another sharp shock, but it should be enough to make the bulls a little more skittish for awhile.
Today we will start with the first question, touch on the second one, and push the third one off until tomorrow morning.
The 1993-94 Lows
Looking at the history books, prior to 2006, the VIX closed below 10.00 on five occasions: four consecutive days in late December 1993; and once in late January 1994. In all instances, the VIX rebounded sharply higher 3, 5, 10, 20 and 50 days later. For the record, the SPX was little changed in the 3/5/10/20/50 day time from the four consecutive days in December 1993, but did sell off following the January 1994 low.
The details are as follows:
Sub-10 VIX #1-4) On 12/23-24/1993 and 12/27-28/1993 the VIX closed at 9.31, 9.48, 9.70 and 9.82, respectively. For comparison purposes, the SPX closed in the range of 467-471 during the same period. Three days later, the VIX was already up 6%, 10%, 10% and 19%. By the fifth trading day, those same gains had been extended to 15%, 23%, 30% and 21% from those closes. Ten trading days from the VIX lows, the VIX was up 21%,16%, 11% and 15%, while the SPX was anywhere between flat to up 1.0%. Twenty trading days from the lows, the VIX still showed cumulative gains of 20%, 17%, 20% and 16% from the original lows, with the SPX flat to up 1.6%. The more dramatic action came in the next 30 trading days, as 50 days from the original lows, the VIX was trading between 14.41 and 16.23, for cumulative gains of 72%, 50%, 57% and 47%. By the 50 day mark, the SPX had drifted down slightly, between -0.6% and -1.0% of the corresponding December close. The bottom line: the VIX was a good long at these lows and the SPX did not move for the next 50 trading days. In fact, there was no substantial drop (single day or cumulative) in the SPX until February 1994 and the SPX drifted sideways until the end of March 1994.
Sub-10 VIX #5) About a month later, on 1/28/1994, the VIX closed at 9.94, the last time it would close that low until November 2006. Looking at the same 3/5/10/20/50 day trading frame, the VIX rallied from that low to 10.61, 15.25, 14.46, 14.87 and 16.62, representing gains of 7%, 53%, 45%, 50% and 67% from the low. This time there was movement in the SPX, as it posted moves of +0.7%, -2.3%, -1.8%, -2.4% and -6.5% over the corresponding 3, 5, 10, 20 and 50 trading day periods. The big move behind the SPX numbers was a -2.3% drop in the SPX on the 5th trading day following the 1/28 low. This also happens to be the 28th, 29th, 30th and 31st trading day following the four consecutive December 1993 VIX lows. For the next 65 trading days, the SPX slid steadily lower, from 469 to 460, before dropping another 21 points over the course of four trading days.
Sub-10 VIX #6-7) On 11/20-21/2006, the VIX closed below 10.00 for the first time in a dozen years. While the 50 day ROI calculations are still two weeks away, the 3/5/10/20 day analysis shows gains of 8%, 17%, 13% and 3% for the first date and 24%, 9%, 14% and 4% for the second date. These VIX lows occurred in the fourth month of what is now a continuing six month upward move in the SPX, which has it currently 2.7% and 2.8% above the corresponding November values. There was a -1.4% drop in the SPX three trading days after one close and four trading days after the other close, on 11/27/06. I would not consider this drop to be noteworthy, however, as it was fully retraced over the course of the next two trading days and indeed the SPX has moved decisively higher over the past two months.
To say that the VIX has closed under the 10.00 mark nine times is to stretch the truth a bit, as some of these daily closes might better be considered as multiple instances of two short-term volatility lulls in late 1993 to early 1994 and late 2006 to early 2007. Each of these two periods had a multiple days of consecutive sub-10 closes followed by an “echo low” approximately one month later. So far, today’s sub-10 close can only be considered another echo low, until we see how the balance of the current VIX lull plays out.
Tired of being shut out of the latest thinking on implied volatility at Goldman, Credit Suisse or BGI? Think your interests are too narrow and arcane for normal web searches because the type of information you’re looking for is relegated to obscure monthly and quarterly journals? I think I may have a solution, albeit an imperfect one.
Thanks to the omniscient folks at Google, you can cherry pick pearls of wisdom from the leading academic journals across the globe without even having to leave your browser. Google Scholar, which bears the motto, “Stand on the shoulders of giants,” is not to be taken lightly. I asked for articles on VIX and volatility from just the past year and got 53 hits; searching the entire database yielded 693 articles.
From Jason Goepfert via the virtual pen of Steve Sjuggerud and archives of Investment U and comes several VIX-related ideas that are worth mulling over 1 ½ years after they were published.
Goepfert, who heads up Sundial Capital Research and sentimenTrader.com, attempted to reconstruct what historical VIX data might have looked like if it were possible to simulate VIX readings all the way back to 1900. In this manner he developed what he calls a Faux-VIX that looks back over a century. As described by Sjuggerud, Goepfert determined that while current VIX readings look quite low by the historical standards that cover two decades of official CBOE VIX/VXO data, looking back to 1900 with the Faux-VIX, it appears that volatility readings below the current 11 level happen approximately one third of the time.
Fear is a strange animal. It is easy to unleash, yet hard to put back in a cage. It spikes up, but rather than spiking down, it tends to slowly subside over time.
In the stock market, there are many factors that may spook investors. In the future I am considering trying to construct a formal Taxonomy of Fear, but for now, let me offer some examples. In the global political arena there are fears that range from terrorism, nuclear proliferation, Middle East tension, and a war in Iraq that could spiral out of control, to the spread of socialism in South America, China playing hardball with the renminbi, Russia throwing their weight around with energy and natural resources, etc. On the macroenomic front, is it inflation or deflation we should be more concerned about? Throw in the possibility of a recession, productivity declines and a hiccough in the job creation engine and there is the potential for a stagflation stew. Really want to make it nasty? Add a dollop of bird flu or SARS on the health front, sprinkle in some peak oil talk and the possibility of another large hedge fund or two imploding and you can see how emotionally charged the investment horizon can appear.
These are not one day events, either. These are the types of issues that grab headlines day after day after day. Whether or not the reality of the situation is worsening, play in the media will manage to keep these issues in the headlines and top of mind for the investment community – and with it, a sense of fear.
Very few of these fears can be defused overnight. The geopolitical issues, in particular, tend to persist for decades, with relative visibility ebbing and flowing over time. For the most part, economic fears and health fears are not going to be quelled in the short-term either. At best, they may come and go in cycles and even if they do fall off of our radar, new concerns are likely to bubble up to take their place.
Ultimately, fear spikes, often instantaneously, and leaves an emotional imprint. If too many unsettling events -- or even one event of seismic proportions -- result in the piercing of the comfort threshold of the average investor, then echoes start to show on the tape and fear cannot be put back in the cage.
The data make this clear. The VIX, which in some respects resembles fear, is seven times more likely to spike up three standard deviations in one day than to spike down; it is fifty times more likely to trade three standard deviations above its 10 day moving average than below it. Asymmetrical VIX spikes are not just an issue of frequency, but one of degree too. On the 26 days that the S&P500 has fallen by 3% or more in a single day, the VIX has spiked up an average of 16.8%. Conversely, on the 33 days in which the S&P has risen 3% or more, the VIX has fallen only 9.2% on average.
"This means that the relationship between the actual VIX index and the VIX options “based” on that index are little hard to follow."
"In simple terms, trading VIX options is like trying to trade options on the temperature at some future date. If, for some odd reason, the temperature in south Florida reaches 120 degrees on October 5, that does not help someone to predict the temperature on February 5 of next year. Perhaps, if there a string of 120-degree days, then, maybe, there could be a trend that might presage a warmer winter and a higher than normal temperature on February. Under normal conditions, however, what happens to the temperature on one particular day in September bears very little relationship to what weather will be in February."
| Week | Current Week | Current + 3 Weeks |
| Week 1 2007 | 2 | 166 |
| Week 2 2007 (-1) | 4 | 262 |
| Week 3 2007 (opt exp) | 45 | 307 |
| Week 4 2007 (+1) | 115 | 282 |
| Week 5 2007 | 98 | 202 |
| Week 6 2007 | 49 | 104 |
| Week 7 2007 | 20 | 55 |
First, why do I care about the VIX? Is it a better indicator than some of the other calculations or market volatility or, more broadly, investor sentiment? The answer to those questions will be addressed in future entries, but unlike other sentiment indicators, one can trade options (since February 2006) and futures (since March 2004) on the VIX in a fairly liquid market, with 14 years of historical data to provide fodder for trading strategy development:
More importantly, even a cursory inspection of the VIX data shows that there is a strong tendency to revert to the mean. As a result, oscillators such as the CCI, Williams %R, and RSI, among others, are reliable in terms of calling tops and bottoms in the VIX. The bottom line is that this makes the VIX highly tradeable. For more information on publicly disclosed VIX trading strategies, check out:
we identify four macro-periods:
The macro question is when the current trend of decreasing volatility will end and if we will see volatility back in the 20s for more than a couple of days a year.
Having touched lightly on several topics above, I intend to drill down in more detail in the coming weeks.