How to Trade a Surging VIX, By the Numbers

In honor of our latest CBOE Volatility Index (VIX) pop, I decided to renovate my overbought VIX table a bit. From now on, I'm going to "Just Say No" to overlaps. If VIX goes overbought 29 days after the last time it went overbought, that data point will not make the cut into the one-month returns column.

This tweak didn't actually impact the one-month returns much, though it did knock down the three-month returns -- more on that in a few.

Previously, I only tracked the one-month and three-month returns of a strategy that goes long SPDR S&P 500 ETF Trust (SPY) anytime VIX closes greater than 20% above its 10-day simple moving average (SMA). Now, I will track a third strategy. What if you buy SPY when VIX closes greater than 20% above the 10-day SMA, and hold until VIX closes back below? I include that in the "VIX Close <10 Day" column. And, finally, I include the duration (in trading days) of that "new" strategy.

I will still go back to March 2009 so as to compare VIX Regime Apples to VIX Regime Apples. Spoiler alert -- no strategy that involved buying anything and holding for any measurable time period worked well in 2008. So, without further ado, here we go.

We now have 19 distinct overbought VIX instances since March 2009. Buying SPY on the first overbought VIX close has worked eight straight times, although the instance on July 17, 2014, only produced a 0.01% win. Overall, the trade won 10 times in 15 tries, for an average win of 2.22% and a median win of 4.83%. That compares very favorably with a randomly timed one-month hold, which has had an average return of 1.31% and a median return of 1.83%.

Going out three months minus the overlaps, we find some serious sample size issues. We now have only 10 occurrences, with five of them produced winning trades -- but just randomly buying and holding for three months worked better. Again, there's not enough data, but it's likely this isn't a useful signal out three months.

And, finally, buying SPY and holding until VIX closes back below the 10-day SMA has produced average returns of 0.13% and median returns of 0.57%. It has won 11 out of 18 times. This trade has taken an average of 5.5 days to hold.

I wouldn't get carried away with these returns so much as the bigger-picture concept. It suggests that the market typically has stabilized within a week of VIX going overbought. There are also very few clustered incidents.

Also, if you prefer buying into strength off the low, as opposed to fading the initial VIX pop, the numbers suggest you are barely the worse for wear. If you wait until VIX has dropped below the 10-day SMA, and then hold for three to four weeks, you will come close to replicating the results of buying when VIX goes overbought and holding for a month.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.