Tuesday, November 8, 2016

Implications of Persistently Elevated VIX/VXV Ratio 11-8-16

Click on Stats to Enlarge

The VIX is a measure of implied volatility in options with an expiration of about 30 days.  And I have discussed the VIX in relation to the VXV many times on this blog.  The VXV is a measure of implied volatility in options with about 90 days to expiration.

When the shorter term VIX is above the longer term VXV, there is a theoretical imbalance occurring.  This indicates "fear" or increased demand for options which are used as a hedge.  So we see the ratio spike on sell offs in the markets.

Currently the VIX/VXV ratio is on its 4th day in a row above 1.0.  The VXV has limited history only going back to about 2010.  So we don't have a lot of data and information from prior bear markets to assess this ratio in downtrending markets.  But there have only been a few periods where the ratio has stayed elevated above 1.0 for a significant stretch over many days or even a few weeks.

Also, of note yesterday and today is that we are seeing a large rebound in stocks, with a big drop in the VIX, and yet the VIX/VXV is staying above 1.0 as of current readings this afternoon.  Typically after stocks bottom and the big initial few days of rebound occur, the ratio gets back below 1.0.

So I looked at times when the VIX/VXV ratio was above 1.0 for two consecutive days where both days were UP in the SPY etf.  There was a negative skew in forward looking time frames on this scan, though the instances are limited.

Then I added the further criteria that yesterday was up more than 1% in SPY (like our current situation).  So yesterday was up big, and today is up again, and yet the ratio is still maintaining a reading in the "fear" zone.  The results of the scan are shown in the chart above and demonstrate that over the short term, stocks were volatile and had a negative skew.  Basically until the ratio drops back below 1.0, there is not an "all clear" type of return to normal signal for the markets.

So in the current situation, it makes sense that short term hedging demand is increased with the election results still ahead tonight.  But don't be surprised if there are some wide gyrations in coming days or weeks, because this ratio indicates that underlying sentiment has not unwound back to normal yet.

The past area where we saw this type of behavior were after the bulk of a correction was done, but moving forward there was some wild gyrations in the process of retesting a bottom.

So I would expect to see a retest of last weeks lows in the coming week or 2.


1 comment:

  1. I have run a few back tests based on developing action today. Until I see the close, they are just "what if" scenarios. The balance seems pretty neutral from what I have looked at today. Things are obviously not "normal" right now. My guess is that things may remain more erratic than normal for several more days. The VIX is down big again today. And in the past there has been a negative skew looking forward from these very large declines in the VIX.