There is a rather persistent negative correlation between the stock market and the VIX, in particular the S&P 500.
Except that last Friday and this Monday, the VIX and the market were moving in the same direction.
Volatility clusters, and abnormalities in volatility also cluster - and do so around times when volatility is spiking.
If anyone doesn't know yet based off this month, and VIXmageddon in 2018, and the 2008 financial crisis - the VIX, or fear index as it's known to have been called from time to time, rises quite rapidly when the stock market falls. There are all sorts of reasons for this, but the primary one is that the index is made up of option prices on the stock index, and as markets fall, people pay more for the Put options the falling market is getting closer to (or through). The end result is a rather persistent negative correlation between the stock market and the VIX. And, in particular, the S&P 500.
Here's what that looks like via the rolling 30-day correlation between the SPY and VIX, with the logarithmic trend line down there around -.80.
Cool... All's well in the world - and VIX goes up when stocks go down. Except... every now and then, what happened last Friday and this Monday happens:
Wait... what? How are they moving in the same direction when they are negatively correlated? Well, a few things.
- Just because they have been negatively correlated doesn't mean they will be negatively correlated on any one particular day... or back-to-back days. Especially, and this can be point two...
- ... When the VIX is up close to all-time highs. We spoke on a recent podcast with Deepfield Capital's Bastian Bolesta about a theoretical upper bound for the VIX, and there is a little bit of that going on.
- They are two different instruments, with a bit of a mismatch in what time frames they are looking at. The S&P, and the stock market in general, is a forward-looking indicator looking as much as 12 months out on what the economy and company earnings are likely to look like. The VIX is measuring the expected annualized volatility over the next 30 days.
What the VIX Peeps Say
Confusing, indeed. Which led us to reach out to our VIX peeps on Twitter and via email and ask what the xxx is going on. Here's how these pros view this phenomenon:
At these high sustained levels of volatility, the transmission mechanism between the underlying and derivatives market "breaks down". There is just too much "noise" in the market for this relationship to function. The malfunctioning of these "markets makers" and lack of liquidity at these levels do not help . Furthermore, some of the high frequency traders taking roles of market makers at low volatility cease to provide liquidity at high volatility. - Anonymous
VIX is a very misunderstood instrument. Many people erroneously believe that it simply goes up when the market goes down and vice versa. That is not the case. VIX moves with volatility. Market volatility can and does move in the same direction as markets from time to time. Market volatility can increase with rising markets and market volatility can decrease with falling markets. Therefore, what we have seen play out in the last three days is nothing more than a low-probability, but fundamentally possible, outcome. We view the decline in VIX has gotten ahead of the math. But in these environments, none of us should be surprised if short-term dislocations occur.
Furthermore, the options market likely sees the stablization of new COVID-19 cases in parts of Asia and the hope of stimulus as bullish. Therefore, rather than buy equities, market participants have elected to play the bullish scenario by selling volatility. Hence, the wind seemed a little at the backs of those trades, at least for now. This whole situation will take months and quarters if not years to play out. We have not seen the last of opportunities. - Timothy Jacobson, Pearl Capital Advisors
In most cases, the VIX spot price isn't terribly useful as an indicator of equity strength or weakness. Much more useful is the VIX futures curve, which also depressed significantly even as $SPX was dropping today. This is actually not terribly different than what happened a week earlier, but in reverse. The VIX futures curve provides general insight into the risk perception of the broader market. Today, the market is positioning for a US fiscal stimulus package that is expected to strengthen the markets. Despite being voted down twice in the senate, it is apparent that even if it takes a couple extra days, there will in fact be a massive stimulus package. The shift lower in the VIX complex today is a reflection of that expectation. Nobody really wants to be caught holding long volatility at 70 when the market calms.
Keep in mind that implied volatility peaks long before the equity market bottoms. Also consider what VIX at 75 means. It is generally an indication that a 1 standard deviation move in $SPX would be nearly 5% on a daily basis. Even if the equity markets are expected to continue lower, it would be presumptuous to assume that daily moves will continue to be on the order of 5% over an extended period. At some point, the daily moves must calm somewhat, and even if they were to remain in the realm of 3% per day, the VIX must then drop below 50 to accurately reflect expected realized volatility. - Brett Nelson, CIO and Founder - Certeza Asset Mgmt.
How frequent is this?
The Joe Tigay tweet saying there were six months of VIX lower, market lower back in 2008 piqued our interest, so we went to the tale of the tape to see just how frequent this reversing of the normal negative correlation is. Here's what we found looking back day after day all the way back to January 1997 (about 23 ¼ years)... and after filtering out days in which the S&P moved less than 1% in either direction.
- 88 out of 5,847 days (1.5%) in which SPY and VIX moved in the same direction (with SPY moving more than 1% up/down).
- 48 of those days (0.82%) were SPY moving up more than 1% and VIX also moving up on the day.
- 40 of those days (0.68%) were SPY moving down more than -1% and VIX also moving down on the day (2 of those were last Friday and this Monday).
- The Up/Up days saw an average move across both of just 2.09%, and max of 8.67% (May 5th, 1997).
- The Down/Down days saw an average move across both of just -1.96%, and min of -6.39% (8/25/15).
- Last Friday and this Monday were the 2nd and 3rd biggest down/down dislocations in the past 23 years.
Here's the chart plotting the occurrences per month - blue SPY Up/VIX Up and orange (SPY Down/VIX Down) - and a few things stand out. One, this is yet another argument supporting the finding that volatility clusters. Abnormalities in volatility also cluster - and do so around times when volatility is spiking. Two, there were lots of up/up days in the late '90s during the internet boom, showing that upside volatility is a real thing - we just haven't really witnessed it in quite some time. And finally, it's interesting to note that it has become a rarer and rarer occurrence since the financial crisis and Fed interventions, and all the rest. Is this the Fed put showing itself in the stats? Or just a result of the extra-low vol regime we've been in?
Happy VIX'ng from home!
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.
Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.
Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.
Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.
Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.
RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.