Weekly ETF SPY: Is The VIX Already Stretched Too Far?

The VIX has rallied more than 30% in 2 days. This VIX move is in harmony with VIX seasonality. How much up side potential is left after such a huge move and what are the odds of further gains?

On February 14, we took a closer look at VIX seasonality. The featured VIX seasonality chart is one of the most unique VIX research tools. It predicted a VIX spike in late February.

The February 14 article pointed out that: “The average February to March VIX spike is less than 10%. Obviously, there’s more potential upside in 2013 as the debt and deficit ceiling quandary has the potential to springboard the VIX from its 73-month low.”

From low to high the VIX jumped 31.57% the last two days (Tuesday – Thursday). Now what?

Yesterday’s strong follow through pushed the VIX above the upper Bollinger Band. A close above the upper Bollinger Band is generally an indication of an overbought condition.

Obviously the tight VIX trading range has compressed the Bollinger Bands and narrowed the spread between the upper and lower band. This may lessen the effect of this signal, but it shouldn’t be ignored.

On February 4, the VIX also closed above the upper Bollinger Band (black arrow on the chart). The VIX was back below it the next day and the S&P closed at 1,511. The close below the upper Bollinger Band was a VIX sell signal (buy signal for stocks).

From there on the VIX almost declined 10% while the S&P 500 rallied as much as 20 points.

Yes, those aren’t huge moves, but small trading profits pile up too over time. More importantly, the Bollinger Band provides a stop-loss guideline for VIX long position (i.e. VIX calls or VIX ETFs like VXX or TVIX).

How so? A close back below the upper Bollinger Band usually means that the VIX spike is ready to pause (or already over). It might be time to ‘eat your ice cream before it melts.’ In other words, lock in gains.

In rare instances the VIX will “climb up the Bollinger Band” (an expression coined by one of my subscribers). This usually coincides with a waterfall decline in equities.

Unless the major averages drop below nearby key support, such an event is rather unlikely.