Hearing VIX footsteps
12/11/18

●The VIX recently traded to its highest level since late-October

●Divergences between the SPX and VIX sometimes signal reversal points


 

The Cboe Volatility Index (VIX) is a little like your grade-school principal: Usually out of sight, out of mind, but when he or she stepped into your classroom, there was a good chance something bad had happened.

Recently many traders have been hearing the footsteps of the VIX—the so-called “fear” index derived from SPX options—coming down the hall. If the S&P 500 (SPX) makes another lower low (especially on a closing basis), watch to see if the VIX is higher or lower than it at was previous swing lows. It may indicate whether market fear has—at least temporarily—peaked.

Many traders watch to see if the VIX is either “confirming” the SPX—that is, declining when the stock index rises, and rising when it falls—or diverging from the typical relationship by moving in the same direction, particularly during sharp market selloffs when the SPX is breaking below a prior swing low.

When the market falls sharply and fear abounds, the VIX typically soars. For example, when the S&P 500 (SPX) plunged 3.2% on last Tuesday and followed up on Thursday with a 2.9% intraday drop, the VIX jumped a total of 58% to 25.94, its highest level since October 29.

In terms of the typical SPX-VIX relationship (the two usually move in opposite directions) and, specifically, the relationship of the two vis-à-vis the market’s November 23 low and last Thursday (December 6), the VIX did what it was “supposed” to do—that is, it made a higher high on December 6 than it had on November 23, reflecting a greater level of market anxiety as the SPX broke to a lower low (right side of chart):

S&P 500 (SPX) and Cboe Volatility Index (VIX), 9/24/18–12/10/18. Less fear at a low vs. more fear at a low.

Source: OptionsHouse


But the SPX also battled back last Thursday to end the day well above the November 23 close, and the VIX closed just below its November 23 close and at the bottom of its daily range—again reflecting the typical SPX-VIX inverse relationship.  

In contrast, when the SPX made a much lower low and close on October 29 relative to October 11, the VIX made a lower high and close on the 29th—suggesting the market was experiencing less fear at the new low. A seven-day rebound followed. (The same thing happened on a smaller scale between November 20 and November 23.)

Friday’s weak price action may have reflected the fact that the VIX did not indicate the market was less fearful on Thursday’s drop than it was on November 23. Yesterday was a mixed message: When the SPX traded below the December 6 low (as well as the October and November lows) on an intraday basis, the VIX matched—but didn’t exceed—its December 6 high of 25.94. Late in the trading session, though, the VIX was positioned to close above its December 6, November 20, and November 23 closes, suggesting there was, at the end of the day, more “fear” (despite the strong intraday rally) than at those previous SPX swing lows.

So if the SPX makes another lower low (and close), watch to see if the VIX level is higher or lower than it was at recent market lows. It could indicate whether market anxiety has run its course, at least for a while.

Market Mover Update: Yesterday British Prime Minister Theresa May postponed today’s scheduled parliamentary vote on her proposed Brexit deal, and the British pound broke below the support level discussed in “Brexit, stage left.”

Today’s numbers (all times ET): NFIB Small Business Optimism Index (6 a.m.), PPI (8:30 a.m.).

Today’s earnings include: DSW (DSW), Casey's General (CASY), Dave & Busters (PLAY).

 

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