The VIX Spike Conundrum

I have been absolutely astonished by the number of comments I have seen in the past few days to the effect that right now is an excellent time to initiate new long positions on VIX options. I am still not sure what is behind most of this thinking, but it seems as if quite a few investors are excited about the VIX breakout, some have adopted a Roubiniesque pervasive pessimism and others clearly are still operating under the shadow of the 2008 volatility spikes.

For all those who think that a VIX spike of 50% is a good time to get long the VIX, my response is that your ship has already sailed.

I gave this post the title of The VIX Spike Conundrum because like a hot Chinese solar stock, a rising VIX seems to be attracting the momentum crowd. Betting that a 50% rise in the VIX is just the beginning of a larger move is a sucker’s bet. In the event that readers find the data in the two studies linked at the bottom of this post not to be sufficiently compelling, I have added a new study that looks at what happens to the VIX following the first time it spikes high enough to close above 30. Not surprisingly, it is yet another example of mean reversion at work.

The graphic below is a histogram that summarizes the future VIX action after an initial close above 30. Of the 51 instances the VIX closed above 30 without having closed above 30 in the previous session, 18 times the VIX closed below 30 on the next day and an additional 12 instances reflect the VIX closing below 30 two days hence. This means that 59% of the time the VIX has surrendered the full distance of the close above 30 as well as some additional territory in just two days. Looking out four days, the VIX has already closed below 30 some 75% of the time, as is shown by the dotted red line.

Note that while 84.3% of the time the VIX has already closed below 30 just six days later, the remaining 15.7% of the instances can make or break a trader. Six times (11.8%) the VIX has remained above the 30 level for at least 23 consecutive days following the first close above 30. This is slightly more than one full options cycle. Prior to October 2008, traders who were short VIX calls could reasonably expect that the VIX was not going to spike any higher than 45, which was the all-time record in the VIX at that time. Now that we have had front row seats to witness the VIX spike above 80 on two separate occasions, I suspect investors overestimate the likelihood of a VIX spike of this magnitude happening again. Short of another acute systemic threat, I would be quite surprised to see the VIX rising over the 45 level.

In the current market environment, the odds favor short volatility positions, such as bear call spreads on the VIX. Long positions in VIX calls are not just low probability plays, but they are very expensive as well. I don’t mind, however, if speculators are eager to gobble these up, as I am glad to have a ready audience to buy some VIX calls.

For related posts on this subject, readers are encouraged to check out:

• VIX Spike of 35% in Four Days Is Short-Term Buy Signal
• Long the SPX on New VIX Record Closes

Disclosure: Short VIX at time of writing.

Comments

[Tony Petroski:]

Vix. The Vaporub people? I would go long with them.

Nov 03 10:43 AM

[talld:]

Here is a graph which shows the correlation between the big funds trading and VXX. The interest in trading it did not increase, I believe the number of people writing contracts lessened which drove up the pricwe.

seekingalpha.com/insta...

Nov 03 11:51 AM

[Surly Trader:]

A long VIX position at this point is a bet on a massive market correction looming. It would make more sense to me to short indices rather than go long VIX now from a risk/reward standpoint. Playing with a long position on the vix at 30 is either going result in modrate gains from a small chance of another leg up or a large chance of catching a falling knife. I would rather sell options at these levels and make my directional bets with futures or etf's.

Nov 03 11:53 AM

[halamok:]

In 05-08 many (especially value-kind of) investors believed buying stocks as the VIX spiked was the way to go. This worked well,but completely failed last October.
Now people tend to buy (expensive) puts on those VIX spikes,amazing how fast people can change their mind,based on the latest performance of a methology.

Nov 03 02:57 PM

[contango:]

THETA positive VIX trade...perhaps on Dec options?

Nov 03 09:41 PM

[Moon Kil Woong:]

I agree with Surley. Clearly the market has been upwards skewed for such time. There is no proof it is reversing and thus no reason for a big short term spike to make going long upwards volatility payoff. It is much more likely than any rise in volatlily will be caused by a downward slide in prices.

Nov 04 01:32 PM

[bottoms-up:]

Why is anybody surprised? I've always seen the VIX as a chicken or egg thing, but really, look at things...

The Fed and US Govt is telling us that everything is zipping along, equities are within 4,000 or so of where they were before we went off the cliff... Then you look at what people like BB do, rather than what they say, it's evident we are in real trouble and the U.S. is not going to spend the taxpayer $$$$ as a way to get out of this.

You've got all forts of garbage statistics out there from the government, ADP, etc. Just wait 30-60 days when the "revision" comes out when nobody is looking. You even have people touting about how much the Baltic Dry has improved (30 percent) at the 3,000 level. Well, the Baltic Dry is off 75 percent of the 2008 high and it take a lot more than 3,000 for shippers to break even. So much for garbage statistics...

Nov 04 02:50 PM