Tuesday, August 9, 2011

Looking for Mean Reversion: "VIX Sets Some New Records, Suggesting Volatility Near Peak" (VXX; TVIX; XIV; IVO; XXV)

We were fortunate to be on the right side of this little beastie since 15.95 on the index. Now some words of caution.
From our June 20, 2011 post "On the Pointlessness of Following the VIX" (VXX; TVIX; XIV):
Two words: Mean Reversion.

While Jeremy Grantham called profit margins the "most mean reverting series in finance" the VIX has to be a close second.

And for newbies to this racket the XIV is the VelocityShares Daily Inverse VIX Short-Term ETN.
From MarketBeat:

The VIX is down nearly 4% today, to roughly 21, retreating quickly from its three-month intraday high last week of nearly 25. Does this mean we should expect more gains in the stock market? Probably not, according to S&P chief equity strategist Sam Stovall.
That’s because the CBOE’s volatility index, often inaccurately called the “fear index,” pretty much tells you nothing about the future whatsoever, Mr. Stovall writes in a note today.
Could investors have anticipated that a decline in excess of 5% was coming, based on a pick-up in volatility, be it intra-day or day-to-day percent increases in the S&P 500? I have found that volatility is more a coincident or lagging indicator, than a leading one. Since 1950, during any given 20-day period, the S&P 500 saw an average 15 days in which intra-day volatility exceeded 1%. Yet this volatility measure fell to below 5 just before the S&P 500 endured the four recent declines of 5% or more....MORE
And from VIX and More:
Just a week ago the VIX seemed to be lagging behind the growing investor anxiety about fundamental challenges facing the stock market, but after Thursday’s drop of 4.78% in the S&P 500 index and today’s decline of 6.66%, the doubling of the VIX to 48.00 in one week seems right in line with investor fear.  [Those wondering what a VIX of 48 means should consider that the literal translation is a prediction of a 3% or more change in SPX at least once every three days.  See Rule of 16 and VIX of 40 for a more detailed discussion.]

As the chart below shows, a VIX of 48 only puts the current crisis at #7 all-time – or at least dating back through VIX data since 1990. On a closing basis, today’s close was actually the highest closing VIX outside of the 2008-2009 financial crisis.

In studying my VIX data set, however, I was surprised to see that today the VIX set a number of new records. For instance, today marks the highest the VIX has ever closed relative to its 10-day, 20-day and 50-day simple moving averages. All three of these facts loom extremely large in terms of predicting future mean reversion behavior. In fact, I publish a proprietary VIX Mean Reversion Index each Wednesday for the benefit of my newsletter subscribers and today marks the first time that index has maxed out at 100.

I also have my own proprietary calculations for VIX fair value. Today my model puts VIX fair value in the mid-37s, which confirms what the VIX Mean Reversion Index is saying....MORE
XXV is iPath's inverse S&P500 VIX ETN while IVO is their inverse VIX futures ETN.
See also yesterday's "Volatility: "Vix curve implies a ‘systematically important shock event’" (VXX; TVIX)"