Monday, February 28, 2011

Taking a Closer Look at VIX Spikes (VIX; VXX; CVOL)

From Schaeffer's Research:

Monday Morning Outlook: How to Handle a Spiking VIX

Volatility surged last week as stocks took a turn for the worse

...Foreword: There was finally some volatility in the market last week. The S&P 500 Index (SPX) was down 2% on Tuesday, and then fell some more on Wednesday. Over those two days, the index fell a total of 2.6% -- which is its biggest short-term loss since last August. The CBOE Market Volatility Index (VIX), which tends to move in the opposite direction as the market, spiked higher as a result, moving up 35% over the two-day period. The chart below shows the VIX and SPX going back to 2010. The yellow circles denote prior instances where the VIX gained at least 30% over a two-day period.

Previous VIX Spikes

VIX Spikes: When the market begins falling, traders scramble to put on hedges to guard against a significant drop in the market. A popular way to hedge is to buy put options on the SPX. The scramble to purchase these options increases option premiums -- and, in turn, the VIX. That's why the VIX is called the "fear index." Below, we'll see how previous VIX spikes have turned out for the market.
Going back to 2000, there have been 11 other times when the VIX gained at least 30% during a two-day period....MORE