VIX dips and market slips

03/19/21
  • VIX fell to lowest level in more than a year this week
  • Indicator uses S&P 500 options to gauge future market volatility
  • Yesterday’s market downturn followed nine-day VIX decline

When the Cboe Volatility Index (VIX) closed below 20 this week for the first time since February 21, 2020, some market watchers noted the decline in the widely followed “fear index” could be a bullish signal for stocks.1

Perhaps. Aside from the difficulty of attaching any bullish or bearish significance to a particular VIX level, another way of looking at things is that, as a contrary indicator—the VIX tends to fall when the S&P 500 (SPX) rises, and vice versa—it may be worthwhile to watch for signs of potential “toppiness” in the market when the VIX is relatively low and moving lower.

The chart below helps show why. VIX spikes have often accompanied SPX relative lows, which is precisely when it would have been most advantageous for traders to be bullish rather than bearish (e.g., March, June, September, October 2020, and January 2021):

Chart 1: S&P 500 (SPX) and Cboe Volatility Index (VIX), 2/24/20–3/18/21. S&P 500 (SPX) and Cboe Volatility Index (VIX). Nine-day VIX decline to 13-month low.

Source: Power E*TRADE


That basic principle doesn’t necessarily work in reverse, though. Because of the market’s long-term upside bias, the VIX can hover at relatively low levels for a long, long time as stocks grind higher, which can make it a dangerous guide for traders attempting to use it to identify market highs. Nonetheless, it may sometimes signal the potential for near-term market weakness.

For example, traders may have noticed Wednesday that the VIX had just notched its ninth-straight day of making either a lower low or lower close (see chart inset), while also falling to its lowest level in at least a month. As a result, they may not have been surprised by yesterday’s market weakness, since after the 28 other times this has happened since 1998:

The SPX closed lower the next day 60% of the time.

The index’s average return the next day was -0.3%.

Unlike VIX patterns that portend possible market lows, however, VIX signals like this tend (when accurate) to be followed by relatively mild and short-lived SPX downturns. In fact, after the pattern described above, the SPX closed higher on each of the next four days at least 57% of the time, and two weeks after the signal, the index was higher 65% of the time—a little better than its long-term odds (60%) of gaining ground in any 10-day period.2

While the VIX may be able to help traders take the temperature of the market, they need to remember that “fevers” among bulls and bears don’t necessarily have the same symptoms.

For additional information about using the VIX as an indicator, go to “VIX for traders.”

Market Mover Update: After turning lower after reaching resistance last week, May WTI crude oil futures (CLK1) suffered their biggest one-day sell-off in months, tumbling around 8% intraday and falling below $60 for the first time since March 3 (see “Retracements and rebounds”).

Today’s numbers (all times ET): Quarterly expiration (equity and ETF options, stock index options, stock index futures, single-stock futures).

Today’s earnings include: Centrus Energy (LEU).

Today’s IPOs include: Finch Therapeutics (FNCH), Connect Biopharma (CNTB), Movano (MOVE), Instil Bio (TIL).

 

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1 Markets Insider. The stock market's fear index just dropped below a key level that suggests further upside ahead. 3/16/21.
2 Based on S&P 500 (SPX) and Cboe Volatility Index (VIX) daily price data, November 1998–March 2021. Supporting document available upon request.

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