Before the market opens, let's review yesterday's volatility in the S&P 500. The first chart features an overlay of the index and the CBOE Volatility Index (VIX) since 2007.
Yesterday the VIX rose to 22.81, a gain of 30.6% over the previous close. The VIX is nicely explained by Investopedia:
VIX: The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge".... VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.
As the top chart illustrates, the correlation between the S&P 500 and the VIX is inverse but imperfectly so. The lower low in the summer of 2008, when the index nearly dipped to 1200, came with a lower VIX in the upper 20s. More significantly, the unprecedented surges in the VIX above 80 in late 2008 predated the actual index low by over three months.
A key to understanding the VIX is to realize that it is far more volatile than the index to which it is attached. The second chart inverts the VIX values, which helps us see more clearly the greater degree volatility and the fact that the VIX tends to lead the S&P 500.
The 30.6% spike in the VIX yesterday is a bit worrisome. The triangles at the bottom of both charts identify days on which the VIX spiked by more than 25%, something that's happened on four previous occasions during the current recovery. However, the last time the VIX rose by more than 30% was the 31.1% spike on October 22, 2008, the week after the Lehman collapse. Of course the VIX was already above 50 the day before, and the daily range of volatility during that period was astonishing.
Perhaps yesterday's VIX action will prove an anomaly — a reminder of past market anxiety rather than the beginnings of a new episode.
