What Can We Learn From the VIX?

Author: Nathan Rowader
Date: October 15, 2014
Category: Macro Trends
Tags: , , , , ,

Last week the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) briefly reached above 30 for the first time since 2011. This sharp jump coincides with a sizeable decline in the S&P 500 Index, -9.84% from the high on September 19, 2014, to the low on October 15, 2014. So, how is a savvy investor supposed to interpret the jump in volatility? Well before we answer that question, let’s first take a look at the VIX.

The VIX was first introduced by the CBOE in 1993 with the aim of predicting the volatility of the S&P 500 over the next 30 days. Therefore, an increase in the VIX indicates that investors are less certain about the future direction of the market and a wide range of possible outcomes is expected by market participants. It should be noted, however, that a high VIX reading isn’t necessarily bad for stocks since it is a measure of volatility, not market direction. Additionally, high levels in the VIX can indicate a great deal of fear among investors and may in fact present a great buying opportunity. So, let’s now take a look at how the market reacts to different levels of the VIX.

2014-10-blog-rowader-vix2

As you can see, during this timeframe investors were actually rewarded for investing during periods following a high VIX reading, with an average three-month gain of 4.59%. In fact, the highest three-month gain happened following a high reading in the VIX, but the same quintile also shows a large loss of -21.94%. This indicates that while there is opportunity for investors in highly volatile markets, they are, as the indicators suggest, highly volatile. The following histogram shows the three-month returns following a VIX reading in quintiles 1 and 5.

2014-10-blog-rowader-vix-return-distributions

As of October 16, the day I am writing this post, the VIX is currently at 25.20, which places it just at the lower end of the first quintile. If history is any indication of what’s to come, investors should consider looking for opportunities to get into the market, not get out of it since first quintile readings are more likely than fifth quintile readings to deliver positive returns in the following three months.

RISKS

Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.

This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.

Nathan J. Rowader is a registered representative of ALPS Distributors, Inc.

One cannot invest directly in an index.


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