The CBOE Market Volatility Index and Historical Volatility – Providing Good Buying Opportunities!
by Ian Harvey
July 16, 2012
If you're not familiar with the CBOE Market Volatility Index (VIX - 16.74), it's often referred to as the "fear index" because of its tendency to rise when the market falls. What it actually does is use prices on S&P 500 Index (SPX - 1,356.78) options to measure the market's expected volatility over the next 30 days.
TOP OPTIONS TRADES SINCE JUNE 01, 2012
|HLF July 47.50 Calls||53%||APPL Aug 650 Calls||67%|
|DLTR Aug 110 Calls||32%||UIS Oct 17 Calls||79%|
|HSY Aug 70 Calls||56%||TSO Nov 25 Calls||54%|
|NKE Oct 92.50 Calls||49%||HLF July 47.50 Calls (again)||38%|
Below is a chart showing the CBOE Market Volatility Index and the actual 30-day historical volatility of the market. As you can see, the VIX typically trades a bit higher than actual realized volatility. But recently, the historical volatility overtook the VIX. So, by looking back at some prior instances, we are able to see what this means to the market moving forward.
Signal Since 2000
Since 2000, the CBOE Market Volatility Index has traded lower than historical volatility on 48 occasions. Below is a table showing how the SPX did following such a signal. In the month after, the average return easily outperformed what the market typically did (0.41% vs. 0.10%) and the percentage of positive returns were the same. Two months following a signal, while the average return still outperformed, the market was positive less than half the time.
In a Low VIX Environment
The chart below is encouraging for the investor. Specifically, it's a chart of the SPX since January 2002, with the green dots signaling when the CBOE Market Volatility Index was below 20 (as it is now), and the red dots signaling when the "fear index" was above 20. You can see that during the bull market from 2003 through 2007, these signals occurred with a relatively low CBOE Market Volatility Index, and they were very good at marking the bottom of market pullbacks. Being in a similar environment now, it wouldn't be surprising if this were a good short-term buying opportunity.
Below is the return data for the SPX since 2000, following the eight times the CBOE Market Volatility Index was below 20 and actual volatility. It confirms what the chart shows -- that these signals are very good buying opportunities.
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