The VIX staged a historic performance over the last 16 trading days. It took 8 trading days to soar 47% and another 8 trading days to drop 43% to a 72-month low. What’s next for the VIX and what does it mean for the S&P 500?
From December 28 – January 9 the Volatility Index (VIX) dropped 43%. Such deterioration of implied volatility is unprecedented in the 20+ year history of the “Fear Index.”
On Wednesday, the VIX fell as low as 13.22, the lowest level since June 20, 2007. Extremes like this often plant the seeds for massive trade opportunities, they are music to our ears.
Is there any significance to the recent VIX behavior and its 72-month low? What does a low VIX mean for stocks?
VIX/S&P 500 in 2010
A low VIX in 2010 and 2011 always spelled trouble for stocks. On April 12, 2010 the VIX fell as low as 15.23. The S&P 500 topped on April 26 and dropped 17% thereafter.
VIX/S&P 500 in 2011
The same top and drop scenario happened in 2011. On April 20, 2011 the VIX moved as low as 14.30. The S&P 500 topped on May 2 and fell 21% thereafter.
VIX S&P 500 in 2012
In 2012 the VIX stair-stepped as low as 13.30 on August 17. The S&P didn’t top until September 14. Although the S&P corrected as much as 8.8%, the VIX barely moved higher. In fact it still traded at 13.67 on October 5.
What’s the takeaway? As the chart below illustrates, the VIX/S&P 500 correlation was a helpful timing tool in 2010 and 2011, but not in 2012. In fact, the VIX 2012 performance had little correlation to its historic seasonal pattern.
Better Use of the VIX
I’ve found it helpful to extract buy/sell signals via the VIX’s interaction with the Bollinger Band. On December 31 the VIX closed below the upper Bollinger Band.
The January 1, Profit Radar Report stated that: “This is a VIX sell signal and a buy signal for stocks.”
VIX/S&P 500 Outlook
The VIX closed near its high of the day yesterday, forming a possible reversal candle against a potentially bullish RSI divergence. The immediate down side for the VIX seems quite limited. Going long the VIX at current prices provides a much better risk/reward ratio than going short.
Trading the VIX is difficult as options suffer from time decay and futures from contango. VIX exchange traded products – like the iPath S&P 500 VIX ETN (VXX) and VelocityShares Daily Inverse VIX ETN (XIV) – provide exposure to the VIX, but suffer from the same problems as they use options and futures to replicate the VIX performance.
With or without setback, I expect the S&P 500 to labor a bit higher towards key resistance before a possible major reversal.