VIX / Volatility Has Been Crushed. What’s Next?

Volatility has been crushed over the past week. What does this portend for the future?

My friend Jeff Pietsch noted tonight, “…the VIX is as severely stretched below its mean (nearly 20% below its 10-day moving average) as it was above just six short days ago.  This is prospectively bearish for price action going into the end of month under a volatility reversion premise.  I have not studied such volatility crashes recently, but see friend of ETF Prophet, “Cobra” has a post on this same topic today, found here.”

Steven Place also noted the VIX phenomena a few days ago in the comments section.

Let’s quantify the recent VIX action.

• As of the 3.24.11 close, the 6 day rate-0f-change for VIX is -38.78% (variable named VixChg)
• 6 days earlier, on 3.16.11, the 6 day rate-of-change for VIX was +48.34% (variable named Vix6Chg)

This is a very large swing over a short period of time.

Cobra’s contribution has 5 samples, and so it is hard to generalize his results to future events. In fact, when I ran a scan looking for VixChg <-30 AND Vix6Chg > 40, I also found 5 samples, one of which is today. The graph below shows the results of buying VIX at the close and selling at the next close, after this setup. Small sample size aside, 3 of 4 instances have VIX bouncing the next day.

Let’s loosen the criteria and see if we can’t increase our sample size…

• VixChg <-25 AND Vix6Chg >35 yielded 11 samples…
• VixChg <-20 AND Vix6Chg >30 yielded 29 samples, so we’ll use those metrics.

Rules:

• Buy VIX or SPX at the close when VIX 6 day ROC < -20 AND VIX 6 day ROC 6 days ago > 30 (please let me know in comments if this does not make sense. It is the same as the variables, only written out)
• Sell X days later
• No commissions or slippage included
• All VIX history used

Results:

Summary:

• Over the next 5 days, it appears that we should expect some mean reversion for VIX and some weakness for the S&P500.

• Over the next 20 days, consolidation within a trading range has been typical.

• SPX has tended to bottom around 30 days later and shortly thereafter VIX breaks to new lows.

Bottom line, as the Honey Hole study showed, it looks like more volatility is ahead with 3 steps forward, 2 steps back action on the S&P 500.

Bonus — List of SPX results 5 days after setup occurs.

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