The VIX – It’s Not Really Much of a “Fear” Gauge

Every time the market starts to dip a little bit the media starts going on and on about the the Volatility Index which is widely reported as the “fear gauge”.  In case you’re not familiar with the Volatility Index (aka, the VIX), it’s the implied 30 day volatility of the S&P 500.  But there’s two sides to the volatility coin.  And the VIX doesn’t only represent the implied downside volatility, it just measures the implied volatility.

So, it’s not surprising to see this good bit of research from Tobias Levkovich about the VIX and its reliability as an indicators of future returns (via Business Insider):

“Looking back at volatility data reveals that there are much higher probabilities for market gains when the VIX is sitting between 10 and 15 than when it is in the 20-25 range,” wrote Citi’s Tobias Levkovich in his August chartbook. “Levels of 20-25 do not generate good probabilities of market gains.”

At the low 10-15 range, the 3-month, 6-month, and 12-month returns were positive 74.4%, 85.0%, and 87.9% of the time, respectively.

At the low 20-25 range, the 3-month, 6-month, and 12-month returns were positive 58.0%, 55.8%, and 60.5% of the time, respectively.”

In other words, the VIX doesn’t really tell you where the market is headed.  It just tells you that some irrational apes expect it to be volatile, which is a lot like relying on the variance of the sun rising to make your next trade decision….

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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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Comments

  1. In case you’re not familiar with the Volatility Index (aka, the VIX), it’s the implied 30 day volatility of the S&P 500.

    In case you’re not familiar and are not trading options, don’t bother ;)

  2. well, what about higher levels? a vix of 50 almost guarantees a 6 months and 1 year gain, and usually a huge one.

  3. Also implied volatility is reliably above realized volatility.

    Like gold, this is another example of overpaying for (not very effective) insurance.

  4. That depends on what you mean by ‘trade’. There isn’t a cash market, but you can certainly trade VIX on the futures or options market, just like any other index.

    And for Cullen, what does a measure of investor fear have to do with future gains? I would think these things are orthogonal, especially in the short term. In other words, VIX attempts to measure amplitude, not direction.

    A contrarian would tend to think just the opposite, that low VIX readings would correlate with lower returns. In that situation one could envision investors taking outsized risks due to the tranquil market and getting burned when the market turns.

  5. Well yea. We’re seeing currencies depreciate 15% in about one month, but the VIX is still holding. There’s so much volatility and everything is basically out of whack, yet the VIX is still not showing any of this. The VIX is basically useless.

  6. That depends on what you mean by ‘trade’. There isn’t a cash market, but you can certainly trade VIX on the futures or options market, just like any other index.

    Those are all derivatives with their own peculiarities.

  7. VIX only measures volatility of the S&P500, i.e. the US equity market.

    As the S&P500 is currently levitating above a mass of dislocation and correlated volatility in a whole bunch of other asset classes (and countries) the relatively low level of VIX is understandable but, as you note, very illusory as a measure of global “market” volatility. Then again, the current level of the S&P500 could be said to be highly illusory itself!

  8. I think you are just expecting too much of it. If you want to look at currency volatility, there are currency options, but I don’t think there is a lot of trading going on in those.

  9. You guys have to remember that everything is correlated in a crash. All of the previous correlations basically breakdown once panic hits the markets.

  10. If you plot the inverse of the VIX against the S & P 500 and then examine the relationship, you will see that the VIX only tells you what is happening at the moment in the stock market. It has no predictive abilities.