VIX: Preliminary Alert Of Rise Potential, SVXY Strong Caution

by: Peter F. Way, CFA


Hedging-derived Index price increase prospects not unusual, but SVXY hedging forecasts increase credibility of market decline ~ VIX rise.

SVXY market-maker hedging-derived forecasts may have topped out, making long positions hazardous here.

Market-worries are always present; the VIX has an asymmetric forecast distribution not always delivering on promises, but can be violent when achieved.

In the worry mix, now that US Primary Elections are resolved, is the June 23 rd Brexit resolution vote.

It might be smart to shield risk exposures of a temporary nature for the near term.

VIX near-term index price range prospects

Here is an update of our daily hedging-derived market-maker implied forecasts for the VIX.

Figure 1

(used with permission)

The vertical lines in Figure 1 are daily forecast ranges for the VIX CBOE Volatility Index of S&P 500 price uncertainty. The heavy dot in each vertical is the exchange quote for the VIX on the end-of-day forecast. The daily quote splits the range into upside and downside prospects.

The up-to-down proportions are measured by the Range Index, whose numeric tells what percentage of the whole forecast range lies below the current quote. The distribution of daily Range Indexes over the past 5 years is shown in the small blue picture.

The distribution is heavily skewed to the small-downside, large-upside end of the array. That means just the opposite in terms of near-term (often temporary) prospects for S&P 500 Index quotes.

Figure 2 covers a longer period (2 years vs. 6 months) by extracting one day a week from the daily analysis record. It provides a more extensive perspective of the detail shown by Figure 1.

Figure 2

(used with permission)

The row of data in Figures 1 and 2 between the pictures spells out the specific current forecast for the VIX of a high index value prospect of 19.37, +33.1% above the current 14.55. In the past 5 years there have been 93 prior days (out of 1261) with Range Index proportions of 15, so this is not an unusual event. The average worst-case experiences of those 93 were VIX declines of -12.4%, making a "reward-to-risk" comparison for the VIX of almost 3 to 1.

If there was a perfect equivalence between VIX Index moves and S&P 500 Index moves it would imply a "Risk to Reward" ratio of about 3 to 1. Scary?

But the simple linear relationship doesn't tell much. Please see Figure 3

Figure 3

Click to enlarge

source: Yahoo Finance

This data includes 2006, so the 2008-9 experiences are included, most notable as the more extreme next 3-month change in the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) prices. Until the VIX index gets above 15-20 the price changes look pretty symmetric above and below the 0% line.

When the VIX gets up in the 40-50 range, the experience has been strikingly positive for a SPY recovery from the serious market fright that must have produced the large VIX number.

But that's not much help in advance.

Instead, let's look at the VIX Range Index instead of just the publicly quoted VIX Index, the numbers the VIX Futures are based on. Figure 4 tells a different story.

Figure 4

Click to enlarge


This data also includes the 2008-2009 experience, just as does Figure 3. That explains the huge negative Range Indexes [RIs], where market quotes were falling faster than price expectations could adjust. We don't expect to see that recur, so please focus on the denser part of the scatter.

When VIX RIs are low that means the expectation is that the VIX is likely to rise. In turn, that means stock prices - here the SPY - are likely to decline. To show how bad a decline actually occurred, we show the worst SPY drawdowns of the next 3 months after the VIX forecast.

They don't call it the "fear index" without reason. But it helps a lot to see the VIX with the perspective the Market-Makers [MMs] have. That is what the VIX RI provides.

A final caution

The ProShares Short VIX Short-Term Futures ETF (NYSEARCA:SVXY) is structured to provide leveraged moves in parallel to the SPY. When the SPY is endangered, usually so is the SVXY. Figure 5 provides the MMs hedging-derived forecasts for it at this point.

You be the judge of what your portfolio calls for.

Figure 5

(used with permission)


Looks a bit like storm clouds may gather. Time to take in the top sails?

Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information (earlier) helping professional and [now] individual investors discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations. We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So our information presents for their guidance what the arguably best-informed professional investors, through their own self-protective hedging actions, believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided. Our website, has further information.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.