"Be fearful when others are greedy and to be greedy only
when others are fearful" is a well-known adage attributed to the
famed investor, Warren Buffett. What is interesting about his
statement is that up until the 1990's there was no generally
accepted way to measure real "fear" in the markets. Luckily
we now have a few more standard indicators to help with this
Today, the VIX indicator is one of the tools used to gauge
fear. By measuring the implied volatility of the S&P 500
index options, the VIX tells us the market's expected volatility
over the next 30 days. When the VIX (ChicagoOptions:^VIX)
rises, expected volatility of the S&P 500 index (SNP:^GSPC)
rises, and when the VIX falls, expected volatility of the index
also falls. Often a rise in the VIX corresponds to a fall in
the S&P 500 as volatility is associated with falling markets
more than rising markets.
Before the mid 2000's, the market relied on the VXO
(ChicagoOptions:^VXO), which measured volatility of the S&P 100
options (ChicagoOptions:^OEX) to gauge fear. This indicator
is still around, but less popular than the VIX.
Tricks with the VIX
Darell Huff wrote in his book in 1954, "If you torture the data
long enough, it will confess to anything". I am about to do
just that with the Volatility Index.
The VIX typically performs opposite of the S&P 500 and
bottoms when the markets are topping and tops when the markets are
bottoming. This is shown below with a standard chart of the
VIX index compared to the S&P. But, having the VIX
and the S&P on different Axes with one bottoming while the
other is topping can be confusing and counter-intuitive.
Luckily we can look at the VIX differently.
The VIX Flip
One way to analyze negatively correlated assets such as the
S&P (NYSEArca:SPY) and VIX is to inverse one of the
assets. Inherent in a stock's price is a fraction of that
price divided by a measurement unit (the denominator). In the
case of the S&P, it is the S&P price in the numerator
divided by a dollar in the denominator giving us its value.
With the VIX, it is the VIX's price divided by one measurement unit
as well. However, by taking the multiplicative inverse of one
of the assets we can make it a fraction and thus flip its scale,
similar to a mirror image. To do this we simply divide one by
the VIX. The chart below shows that result and the flipped
This does nothing to the data or substance of the VIX or its
relevance; it just changes the scale and puts it opposite of its
original direction. This now allows the VIX to move in the
same direction of the S&P and better compare them apples to
apples with them both now positively correlated. For me it is
often easier to analyze and see trends in the chart below than the
one shown in the chart above.
What is the Inverse VIX Telling Us?
The S&P is in black and the major price peaks in 2010, 2011,
and earlier this year all coincided with tops in the Inverse VIX in
red. It is easier to see on the second chart how the inverse
VIX tops and bottoms coincide with the S&P's peaks and troughs.
Typically those tops also were when the inverse VIX was
trading above .06 which I have identified by the solid black
Using these techniques helped us see great short term VIX buying
opportunities that we outlined in articles on 8/21 (
) as well as 9/20 (
) and in our updates to subscribers. Looking at the chart
above in red, the inverse VIX is in a longer term uptrend that
started in mid 2011, but it is also well above .06. This area
in the past is where tops in the market formed previously and shows
why bulls should be cautious at these lofty levels with complacency
relatively high right now.
The VIX (and inverse VIX) is another tool to have in the
that can be used to take advantage of our VIX trades are the
ProShares VIX Short-Term Futures ETF (NYSEArca:VIXY),
the ProShares Short VIX Short-Term Futures
ETF (NYSEArca:SVXY), and the ProShares Ultra VIX
Short-Term Futures ETF (NYSEArca:UVXY).
Tools such as the inverse VIX can help us identify trends and
setups that otherwise may be missed with traditional analytical
tools. In the
Profit Strategy Update
we examine the VIX and other asset classes in detail to
identify high probability trading setups every Sunday and Wednesday
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