Tuesday, October 2, 2007

More Thoughts and Numbers on the SPX-VIX Correlation

I have used this space to talk about the correlation between the VIX and SPX, the SPX:VIX ratio and an bunch of other related subjects. Some may be ready to scream “Enough already!” but now it’s time we really got serious about the subject.

Let’s start with yesterday. There was a lot of talk (if you travel in certain blogging circles, at least) about how unusual it was for the SPX to jump 1.33% while the VIX moved down only 0.89%. The contention that the move on the part of the VIX was rather tepid seems to make sense in theory, because it is ‘common knowledge’ that the VIX typically moves in the opposite direction of the SPX and at a much faster rate. Where are the numbers to support this belief? Well, I’m going to start trotting them out in this space, but not all at once, so that I everyone has a chance to move to higher ground before the flood hits.

Some numbers to contemplate, using data from 1990:

  • The VIX and the SPX move in the opposite direction on 76% of all trading days
  • On those days the VIX and SPX move in the same direction, the move is more likely to be up than down
  • In percentage terms, the median daily move in the VIX is -4.2x the daily move in the SPX

Getting back to yesterday, the SPX has risen 1.33% on seven previous instances. On all seven occasions when the SPX has risen 1.33%, the VIX has dropped, with a mean drop of 6.3%, a maximum of 10.1% and a minimum of 1.4%. Of those seven previous instances, the SPX recorded the largest subsequent gains (10, 20 and 50 days out) when the VIX dropped the farthest (10.1%); the SPX had the worst subsequent performance (10, 20 and 50 days out) when the VIX dropped the least (1.4%.) I know this is just seven data points, but history is not looking favorably on yesterday’s VIX performance.

I’ll have a lot more to say about this subject, with a lot more statistical significance, in the near future.


Ben Bittrolff said...

Hey, I have a brilliant NEW idea: Lets setup a fancy financial company and issue lots of debt. We then squander the debt by lending to unqaulified people that can't possibly pay it back. BUT we use Level 3 and Level 2 accounting to Mark to Make Belief and Mark To Model. We can than also record the declining value of our own debt (as Bond holders flee in panic) as even more gains. Then we wait for the short bus to pull up and let the Bulltards come in and bid up our shares...

Oh wait, never mind.

Things are strangely quiet... Maybe non-farm payrolls will shake things up a bit, since Pending Home sales haven't...


Bill Luby said...

I like it, Ben. I was also suggesting to Adam Warner that we could always roll out an "Inverse Greenspan ETF," but since Adam appears to be focused entirely on his "new IPO, tentatively named I-China Solar Navigation Systems In Motion (we manufacture solar powered, WiFi-enabled bicycle helmets)" I'm still looking for partners. Maybe a double inverse Greenspan ETF would be better...

All the selling -- what little there has been so far -- is quite orderly. Not a whiff of panic in the air.

Still short and getting more bearish by the hour.



nodoodahs said...

Umm, they can't mark bonds to market because there's no liquidity. This isn't news, folks, other than T's, bonds don't move. Accrued Interest and Aleph covered this pretty thoroughly. Besides, if you're holding corps or MBSs to maturity, you don't give a rat's about the mark as long as you get your yield and the principal returned, and the mark during one hectic month or two in the summer of '07 is meaningless. This is why I think it was so smart for GS to recapitalize their funds.

Interesting that you're short, Bill. This Bill is still long, mostly emerging markets, with trailing stops.

My "favorite" advocate of the SPX/VIX ratio is Ron Sen. I have yet to see him write conclusively "the SPX/VIX is low, it's time to BUY BUY BUY domestic equities!!!!" Apparently it's only a one-way indicator.

Bill Luby said...

Hi Bill,

I would ride that EEM train or whichever variant you are on until the end of the line. Emerging markets have really been amazing over the past year and I'd hate to pick a ceiling there.

With respect to the SPX/VIX, I agree that Ron Sen does a good job, but I'm not convinced the ratio delivers much in the way of good ST setups. At least I haven't been successful there.

Also, I rarely go short anything when indices are making new highs, but I am picking my spots -- and preparing for a more aggressive bear play when the current bull tires. Maybe I just like being early; I called the February drop in December.

Finally, one of the best things about good indicators it that they keep you with strong trends, even when your gut is trying to tell you that things are getting a little frothy. My Overripe High Fliers, for instance, are doing quite well today in spite of the mixed market.

Cheers and good trading,


nodoodahs said...

Re: Ron, I think we got our wires crossed. He only mentions SPX:VIX as a sell, never in a positive tone. To wit, what's the positive outlook on this post from 8/16 which showed a chart of SPX:VIX?


If there ever was a buy on that indicator, that was it. But Ron didn't say "buy" or that he was a buyer.

Personally, I am not a fan of that ratio. YMMV. But even fans of a ratio should be able to see it both ways, bull and bear, you think?

FWIW, I'm holding about 17-18% each of FXI, INP, and EWH with trailings on them, plus a couple other positions. I'm happy to let them stay "irrational" because as long as I'm not short them, I'll stay solvent.

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