The VIX tends to move higher after it first breaks below 15
A recent MarketWatch article caught my eye, pointing out that the Cboe Volatility Index (VIX) has been above 15 for about four months now -- its longest streak since 2012. For those unfamiliar with the VIX, it’s calculated using options on the S&P 500 Index (SPX). The more option traders are paying for SPX options, the higher the VIX. More precisely, the VIX is the expected volatility of the S&P 500 Index over the next 30 days, as measured by the options.
The chart below shows the S&P and VIX since 2014. The VIX typically moves the opposite of stocks. So, when stocks collapsed in December, you saw the VIX reach its highest level since February. Despite the 16% rally in the S&P 500 Index since Christmas Eve, the VIX remains stubbornly above the 15 level. This week, I’ll look at what has happened in the past when the VIX breaks 15 after long streaks above that level. Also, I’ll compare the VIX to a couple of other measures of volatility to see if we can determine whether it’s too high or not.
The VIX Breaks Below 15
The table below shows there were eight instances in which the VIX was above 15 for at least three straight months. I summarized how the VIX reacted going forward after these eight instances. On average, the VIX moves higher after it first breaks below 15. Two weeks after falling below 15, it was higher seven of eight times averaging a gain of 8.81%. Three months after these breaks, the VIX is higher on average by almost 15%, and again, higher seven of the eight occurrences.
The table above insinuates the VIX has a strong tendency to move higher after breaking below 15. This would imply stocks underperform. The table below summarizes the S&P 500 Index after these breaks, confirming the subsequent underperformance by stocks. Three months after the VIX breaks below 15, the SPX averages a slight loss, and is positive just half the time. Typically, in three months the index gains an average of 2% with about 69% of the returns positive.
Breaking Down the VIX, HV and Stock IV
Since the VIX is the expectation of volatility over the next 30 days for the S&P 500, it’s highly correlated with actual observed volatility. This next chart shows the VIX beside 20-day historical volatility (HV) of the S&P 500 Index. The 20 in 20-day HV references trading days. There are close to 20 trading days in 30 calendar days, so it’s roughly the same time frame as the VIX measurement.
Since 2014, you can see the two lines are highly correlated. The VIX, however, seems to have a higher floor than HV. No matter how low the historic volatility goes, the VIX doesn’t seem to go much lower than 10. There are a couple clear reason for this. First, no matter how little volatility that occurs in the past, there’s always potential for something to occur at any time that has a significant impact on the market. Also, there is always a natural demand for S&P 500 put options by money managers who hedge their portfolios. Increased demand puts upward pressure on the option prices. Interestingly, in 2017 the VIX fell below 10. In 2018, when the 20-day HV fell to near five, the VIX floor seemed to be higher than in 2017. Will 15 be the new floor for the VIX? If so, there’s money to be made by selling S&P 500 options.
Below is another chart showing that option prices are currently elevated. The Schaeffer’s Volatility Index (SVI) for a stock measures the implied volatility of individual stocks as measured by front-month options. It’s comparable to the Cboe Volatility Index, except it’s for individual stocks. Below, I chart the VIX along with the median SVI value of stocks currently in the S&P 500 Index. Like the VIX, the median SVI in the S&P is well above its floor during “normal” environments. One reason for the higher-than-normal option prices might be the fact that we’re still in earnings season. Also, the uncertainty surrounding the possible upcoming government shutdown and/or the back and forth trade news with China could also be reasons for higher than expected implied volatilities. If option prices are going to remain high for stocks and the S&P 500 Index, then option traders are going to have to be savvier than normal to get suitable returns.
