Darell Huff wrote in his 1954 book 'How to Lie with Statistics',
"If you torture the data long enough, it will confess to
anything". I am about to do just that with the Volatility
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 which focuses on the
S&P 500. The Nasdaq 100 also has its own volatility
index, the VXN (CHICAGOOPTIONS:^VXN)
Tricks with the VIX
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 long-term
chart of the VIX index compared to the S&P 500.
But, having the VIX and the S&P inversely correlated
with one bottoming while the other is topping can be confusing and
counter-intuitive. Luckily we can look at the VIX
The VIX Flip
One way to analyze negatively correlated assets such as the
S&P (NYSEARCA:SPY) and VIX is to invert one of them. To
do this we simply make the VIX a fraction and plot it alongside the
market. The chart below provided in our ETF Technical
Forecast on 02/24, just before the VIX rallied 34% on 2/25, shows
that result, the flipped VIX.
This chart now allows the VIX to move in the same direction as
the S&P to better compare them apples to apples.
What is the Flipped VIX Telling Us?
The S&P is shown in red and the inverted VIX in black.
It is easier to see on the second "flipped" chart how the inverse
VIX tops and bottoms follow alongside the S&P's very closely.
Using these techniques, along with other technical and sentiment
indicators, helped us see some great VIX buying opportunities that
we outlined in an article on 2/06 (
) with the VIX below the 13 level. We reiterated on 2/10 to
subscribers in our Technical Forecast to continue to hedge downside
risk by buying VIX call options. "The VIX still looks to be
forming a base and given our overall expectations of an eventual
market decline and cheap cost of protection, in the money VIX calls
remain good for hedging positions."
The VIX call options suggested more than doubled as the VIX
rallied as high as 19 and still remains up over 20% from its
mid-February low levels.
Currently, shown by the black dashed trendline in the "flipped"
chart above, the inverse VIX was not making new highs, even though
the market was. That was one sign the VIX was showing
relative strength and a better candidate to hedge your
Currently we are watching a key trendline that will keep the VIX
long trade intact. We also continue to watch the flipped VIX
for continued signs of relative strength. For now, VIX call
options remain the prefered candidate in hedging your portfolio's
The VIX (and inverse VIX) is another tool to have in the
toolbox. Some ETFs that can be used to take advantage of
short-term 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). But,
levered exchange-traded products have many risks
associated with them which is why we prefer the purer VIX play
of using options contracts.
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