Monday, August 13, 2007

VIX and 100 Day SMA

I usually speak of mean reversion in terms of the distance the VIX is away from its 10 or 20 day simple moving average. These are high percentage plays with a good bit of statistical data to support a mean reversion trade.

With all the volatility of the past three weeks or so, the SMA that is getting my attention right now is the 100 day SMA, where the VIX sat 85.2% above the 100 day SMA of 15.28 as of Friday’s close.

This is not quite unprecedented, but since 1990 there have been only 13 trading days – several of which have been clustered together – in which the VIX has closed 80% or more above its 100 day SMA. Without an exception, these have all been excellent times to predict a VIX reversal, as the minimum VIX contraction 50 trading days later has been 18%. Specifically, the mean VIX contraction is 16% in 3 days, 20-21% in the 5/10/20 day period, and a whopping 33% some 50 trading days out.

Given that VIX options still have 8 trading days left for the current cycle, I suspect that the August 25 puts would be a good play, thought the 22.50s probably deserve some attention as well.

Can this gravity defying dance really continue for another week and a half? I’m betting against it.


Anonymous said...

I'm worried that the VIX really hasn't gotten to an extreme level yet that gives us full confidence the bottom is in. If you look back at previous markets where volatility moves from extended low periods to reversing higher, it often coincides with market drops of 10-15-20% and VIX levels have been known to hit 50-80-100 or more. I would be careful thinking the VIX markes a significant low at this point.

Bill Luby said...

Hi Zach,

Your general points are good ones, but for the record, your absolute numbers for the VIX are a little off.

If you look at a monthly chart of the VIX I recently posted you can see that extreme readings for the VIX have always maxed out in the 40s.

That being said, before the current method of calculating the VIX was implemented, the current VXO was was know as the VIX. That index peaked at 56 in 7/02, 61 in 10/98, and was calculated to have reached 172 back in 10/87 -- even thought it did not officially exist at the time.

One of these days when things calm down a little (!) I will put up a 20 year chart of the VXO and talk about this.

While it is not impossible to see 40 in the near future, I'd be very surprised if the current sub-prime situation pushes the VIX up to 35 (of course I didn't think it would make it to 29.84 either.)

Cheers and good trading,


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