From our June 20, 2011 post "On the Pointlessness of Following the VIX" (VXX; TVIX; XIV):
Two words: Mean Reversion.And from VIX and More:
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.
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
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.]XXV is iPath's inverse S&P500 VIX ETN while IVO is their inverse VIX futures ETN.
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
See also yesterday's "Volatility: "Vix curve implies a ‘systematically important shock event’" (VXX; TVIX)"