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Tricks for Reading the VIX
Updated
Understanding VIX Generally
VIX measures the pricing of at-the-money options on the S&P 500SPX SPXUSD where such options have about 30 days until expiration. Higher VIX readings mean that demand for at-the-money options on SPX has risen through hedging or bearish positioning (usually both)—meaning that fear and uncertainty has arisen along with expectations of greater price movement (price declines) and volatility.
In essence VIX tends to jump during major sell-offs in the S&P 500 and other global equity indices, and it also tends to fall back during long, gradual rallies. Its historic average is about 20. The average of all VIX closing numbers is about 19.4.
Further, a VIX reading at 27–28 is at the upper end of one standard deviation from its mean. At the height of the 2008 recession, VIX peaked around 89.5 (intraday) and closed just above 80 several times. In March 2020 amid the Covid-19 pandemic, it surged to about 82.
During the dot-com market from 1997-2000, the VIX held above its historical average (above 20) even though equity markets continued to drive higher for years. This was not a typical period for the relationship between VIX and markets with above average VIX readings coinciding with higher S&P 500 returns (33.1% in 1997, 28.3% in 1998, 20.9% in 1999).
Understanding VIX Readings
In General, High VIX Readings Help Spot Trading Lows or Lasting Market Bottoms
VIX helps spot market bottoms. Some market experts assert that VIX is a measure of stress in the system, a measure of worry and fear as defined by various formulas derived from SPX puts and calls. Readings above 40 on the VIX tend to signal pure panic and indicate either an interim low (e.g., a temporary trading low followed by a bear rally) or a final bottom for a bear market or correction.
The VIX measures implied volatility from a basket of at-the-money front-month SPX options. Ordinarily, VIX and SPX are supposed to head in opposite directions, meaning VIX climbs (or remains elevated) as SPX falls, and VIX falls (or remains low) as SPX rises. At least some other global indices that correlate to some extent with SPX would typically head in the same direction as SPX, but since VIX is derived from SPX derivatives (options), SPX will be discussed primarily.
So the ordinary relationship between VIX and SPX is inverse as shown in the example on the main chart above for the 2000-2002 bear market. Lower SPX lows often coincide with even higher VIX highs.
In the chart below, note how the VIX and SPX held to their usual inverse relationship during the 1998 SPX correction, which involving a decline of about -22% from the pre-correction high. As the market fell, the VIX continued to rise. Each SPX interim low was marked by a higher VIX high. Importantly, each VIX high was a "lower high" relative to the final VIX high that coincided with the final SPX low on October 8, 1998.
Supplementary Chart 1: SPX 1998 Correction Shows Usual Relationship between VIX and SPX
Divergences from the Usual Inverse Relationship between VIX and SPX May Distinguish Lasting Market Bottoms from Temporary Trading Lows
But divergences from the usual inverse relationship between VIX and SPX can sometimes appear, and they may signal a lasting market bottom as distinguished from a temporary trading low. In particular, VIX will start to diverge from the usual pattern of higher VIX highs that coincide with lower VIX lows, meaning that SPX will make a new low but VIX will make a lower high rather than a new and higher high. This can be a helpful trick to understanding how VIX behaves at some major bear market bottoms and corrections.
The primary chart above shows an excellent example from the 2000-2002 bear market. Consider the penultimate interim SPX low in July 2002. The highest VIX close of the entire bear market printed at 48.46 the day before this major interim low on July 24, 2002. (On the actual day of this interim low, VIX fell slightly to close at 39.86).
Corrections also sometimes show this divergence from the usual SPX-VIX relationship. The chart below shows the 1990 correction in SPX where this equity market fell about -20%. Note the divergence between the major interim low in August 1990 and the final correction low in September 1990.
Supplementary Chart 2: SPX 1990 Correction Shows Divergence from the Usual Inverse Relationship between VIX and SPX
Although not shown in an additional chart, the bear market of 2008-2009 following the Great Financial Crisis contains another useful case study. During this bear market, the VIX peaked with closing highs above 80 in October 2008 and an intraday high of 89.53 on October 24, 2008. These were the highest VIX readings of the entire bear market occurring months before the final bear-market low. A VIX divergence appeared at the final bear-market low—VIX made a lower high of 49.33 and an intraday high of 51.90 on March 6, 2009. This is similar to the VIX divergence that was seen in the final stages of the 2000-2002 bear market (shown in the chart above).
Broader Application of VIX-SPX Divergences
This phenomenon of VIX and SPX diverging from their usual inverse relationship also may be stated more broadly as follows: when the VIX moves in tandem with the S&P 500, it’s a usually a sign that the trend may reverse. This occurs whenever VIX and SPX fall together or whenever they rise together.
When the VIX and the S&P are both going down in tandem, this could present a good long-term buy signal especially when combined with other technical or fundamental evidence of a bottom.
Furthermore this divergence from the usual inverse relationship can appear at market peaks as well. For example, when the market rallies higher, but the VIX remains elevated (it rises, does not decline significantly, and holds support), this indicates the rally could soon fail. A rally with elevated VIX shows persistently higher implied volatility / fear—increased demand for 30-day options based on expected volatility / demand for option hedges as downside insurance. This could be a sign the rally is fleeting.
VIX measures the pricing of at-the-money options on the S&P 500
SPX SPXUSD where such options have about 30 days until expiration. Higher VIX readings mean that demand for at-the-money options on SPX has risen through hedging or bearish positioning (usually both)—meaning that fear and uncertainty has arisen along with expectations of greater price movement (price declines) and volatility. In essence VIX tends to jump during major sell-offs in the S&P 500 and other global equity indices, and it also tends to fall back during long, gradual rallies. Its historic average is about 20. The average of all VIX closing numbers is about 19.4.
Further, a VIX reading at 27–28 is at the upper end of one standard deviation from its mean. At the height of the 2008 recession, VIX peaked around 89.5 (intraday) and closed just above 80 several times. In March 2020 amid the Covid-19 pandemic, it surged to about 82.
During the dot-com market from 1997-2000, the VIX held above its historical average (above 20) even though equity markets continued to drive higher for years. This was not a typical period for the relationship between VIX and markets with above average VIX readings coinciding with higher S&P 500 returns (33.1% in 1997, 28.3% in 1998, 20.9% in 1999).
Understanding VIX Readings
In General, High VIX Readings Help Spot Trading Lows or Lasting Market Bottoms
VIX helps spot market bottoms. Some market experts assert that VIX is a measure of stress in the system, a measure of worry and fear as defined by various formulas derived from SPX puts and calls. Readings above 40 on the VIX tend to signal pure panic and indicate either an interim low (e.g., a temporary trading low followed by a bear rally) or a final bottom for a bear market or correction.
The VIX measures implied volatility from a basket of at-the-money front-month SPX options. Ordinarily, VIX and SPX are supposed to head in opposite directions, meaning VIX climbs (or remains elevated) as SPX falls, and VIX falls (or remains low) as SPX rises. At least some other global indices that correlate to some extent with SPX would typically head in the same direction as SPX, but since VIX is derived from SPX derivatives (options), SPX will be discussed primarily.
So the ordinary relationship between VIX and SPX is inverse as shown in the example on the main chart above for the 2000-2002 bear market. Lower SPX lows often coincide with even higher VIX highs.
In the chart below, note how the VIX and SPX held to their usual inverse relationship during the 1998 SPX correction, which involving a decline of about -22% from the pre-correction high. As the market fell, the VIX continued to rise. Each SPX interim low was marked by a higher VIX high. Importantly, each VIX high was a "lower high" relative to the final VIX high that coincided with the final SPX low on October 8, 1998.
Supplementary Chart 1: SPX 1998 Correction Shows Usual Relationship between VIX and SPX
Divergences from the Usual Inverse Relationship between VIX and SPX May Distinguish Lasting Market Bottoms from Temporary Trading Lows
But divergences from the usual inverse relationship between VIX and SPX can sometimes appear, and they may signal a lasting market bottom as distinguished from a temporary trading low. In particular, VIX will start to diverge from the usual pattern of higher VIX highs that coincide with lower VIX lows, meaning that SPX will make a new low but VIX will make a lower high rather than a new and higher high. This can be a helpful trick to understanding how VIX behaves at some major bear market bottoms and corrections.
The primary chart above shows an excellent example from the 2000-2002 bear market. Consider the penultimate interim SPX low in July 2002. The highest VIX close of the entire bear market printed at 48.46 the day before this major interim low on July 24, 2002. (On the actual day of this interim low, VIX fell slightly to close at 39.86).
Corrections also sometimes show this divergence from the usual SPX-VIX relationship. The chart below shows the 1990 correction in SPX where this equity market fell about -20%. Note the divergence between the major interim low in August 1990 and the final correction low in September 1990.
Supplementary Chart 2: SPX 1990 Correction Shows Divergence from the Usual Inverse Relationship between VIX and SPX
Although not shown in an additional chart, the bear market of 2008-2009 following the Great Financial Crisis contains another useful case study. During this bear market, the VIX peaked with closing highs above 80 in October 2008 and an intraday high of 89.53 on October 24, 2008. These were the highest VIX readings of the entire bear market occurring months before the final bear-market low. A VIX divergence appeared at the final bear-market low—VIX made a lower high of 49.33 and an intraday high of 51.90 on March 6, 2009. This is similar to the VIX divergence that was seen in the final stages of the 2000-2002 bear market (shown in the chart above).
Broader Application of VIX-SPX Divergences
This phenomenon of VIX and SPX diverging from their usual inverse relationship also may be stated more broadly as follows: when the VIX moves in tandem with the S&P 500, it’s a usually a sign that the trend may reverse. This occurs whenever VIX and SPX fall together or whenever they rise together.
When the VIX and the S&P are both going down in tandem, this could present a good long-term buy signal especially when combined with other technical or fundamental evidence of a bottom.
Furthermore this divergence from the usual inverse relationship can appear at market peaks as well. For example, when the market rallies higher, but the VIX remains elevated (it rises, does not decline significantly, and holds support), this indicates the rally could soon fail. A rally with elevated VIX shows persistently higher implied volatility / fear—increased demand for 30-day options based on expected volatility / demand for option hedges as downside insurance. This could be a sign the rally is fleeting.
Note
Corrections / Clarifications:The following sentence in the above post contained a typographical error which has been corrected with a replacement *SPX*: "In particular, VIX will start to diverge from the usual pattern of higher VIX highs that coincide with lower *SPX* lows, meaning that SPX will make a new low but VIX will make a lower high rather than a new / higher high."
Note
This following statement needs clarification: "So the ordinary relationship between VIX and SPX is inverse as shown in the example on the main chart above for the 2000-2002 bear market. Lower SPX lows often coincide with even higher VIX highs."The main chart showing the 2000-2002 bear market is an example of *both* the usual inverse relationship between VIX and SPX and a divergence from this inverse relationship. The first several interim lows (April 2001, September 2001, and July 2002 interim SPX lows) each coincided with higher VIX highs. This represents the usual inverse relationship b/w VIX and SPX.
However, the divergence from this inverse relationship is also exemplified on the same chart of the 2000-2002 bear market by the comparison b/w the July 2002 interim low and the October 2002 final low / market bottom. This is because SPX had made a series of lower lows for the final two lows leading to the bear-market bottom while VIX made a series of lower highs.
Note
Further Correction / Amplification: In the introductory paragraphs, this article states that VIX uses at-the-money options on SPX with 30-days to expiration. While the VIX does use options on SPX and while it includes only options with about 30 days to expiration, it appears to include a broader range of strikes now than in the past.In the past, it used only at-the-money options as it was originally designed (see below). The following paragraphs by CBOE (the Chicago Board Options Exhange) explain this in more detail. (The CBOE would be the most authoritative source on this issue.)
"In 1993, the Chicago Board Options Exchange® (CBOE®) introduced the CBOE Volatility Index®, VIX®, which was originally designed to measure the market’s expectation of 30-
day volatility implied by at-the-money S&P 100® Index (OEX®) option prices. VIX soon became the premier benchmark for U.S. stock market volatility. It is regularly featured in
the Wall Street Journal, Barron’s and other leading financial publications, as well as business news shows on CNBC, Bloomberg TV and CNN/Money, where VIX is often
referred to as the “fear index.”
Ten years later in 2003, CBOE together with Goldman Sachs, updated the VIX to reflect a new way to measure expected volatility, one that continues to be widely used by financial
theorists, risk managers and volatility traders alike. The new VIX is based on the S&P 500® Index (SPXSM), the core index for U.S. equities, and estimates expected volatility by
averaging the weighted prices of SPX puts and calls over a wide range of strike prices. By supplying a script for replicating volatility exposure with a portfolio of SPX options, this new methodology transformed VIX from an abstract concept into a practical standard for trading and hedging volatility. "
Here is a very simple explanation (quoting Investopedia) on how VIX is calculated generally:
"VIX values are calculated using the Cboe-traded standard SPX options, which expire on the third Friday of each month, and the weekly SPX options, which expire on all other Fridays. Only SPX options are considered whose expiry period lies within more than 23 days and less than 37 days.
While the formula is mathematically complex, it theoretically works as follows: It estimates the expected volatility of the S&P 500 Index by aggregating the weighted prices of multiple SPX puts and calls over a wide range of strike prices.
All such qualifying options should have valid nonzero bid and ask prices that represent the market perception of which options’ strike prices will be hit by the underlying stocks during the remaining time to expiry."
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While considering 2007-2009 bear market associated with the Great Financial Crisis, I noticed another clear example of the divergence in VIX from its usual relationship with SPX, as discussed above. It seems that the farther apart and more pronounced the divergence is, the more likely it is to be a final low. Another nuance may be present in this relationship, and this has sparked my curiosity during the recent bear market. I'm still thinking and researching it and haven't come to a firm conclusion. But the hypothesis is as follows: The closer the divergence is—e.g., when the two VIX peaks are only a few days apart—and the less significant it is means that the divergence does not signal a final low but perhaps just an interim low, i.e., it suggests that the selling may only be temporarily exhausted, leading to just another bear bounce.
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Here is an example of my hypothesis from this year's bear market. Notice the two lows in June 2022 this year. VIX made a lower high when SPX made the lower June 2022 low. The highest VIX reading in June occurred at the higher SPX low. This is a divergence from the usual relationship b/w the two. Then look what happened afterward—SPX rallied hard into August 2022. But this divergence was more minor than the divergences marking the final low in the 2000-2002 and 2007-2009 bear markets (discussed above). This June 2022 divergence was only a few days apart and less pronounced. But it was enough to signal perhaps the sharp bear rally that ensued. Notably, however, June 2022 lows have now been undercut this month and last month. So the divergence was to minor perhaps to signal a final low, but it was enough to signal an interim low. Just a working hypothesis here.
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And one more example from May 2022, where a minor divergence led to a multi-day bear rally, but the minor divergence did not mark a final low (b/c it may have been too minor)Note
Check out the sequel to this post called "VIX/VIX3M: Tricks for Reading the VIX Part II"
Note
In a previous update to this post, minor divergences were discussed briefly. This update elaborates in a little more detail. The upshot is that minor divergences should be distinguished from major divergences. To understand a divergence, please check out the article above, which explains this concept with regard to VIX vs. SPX. The basic idea of a divergence is that VIX makes a lower high after making a higher high, and VIX's lower high corresponds with a lower low in SPX. This is a *divergence* from the usual relationship b/w VIX and SPX.When VIX divergence are minor, this means the two or three VIX highs are closer together in time and closer together in space (values are closer together). Without having exhaustive data, but having studied a few representative samples from this bear market and prior ones, minor divergences represent less significant ones. In other words, minor divergences occur when VIX makes a slightly lower high within a few days, e.g., 1-10 days, after the previous higher high, and the lower high in VIX of course corresponds to a lower low in SPX. Such minor divergences can signal temporary trading lows that lead to multi-week bear rallies during bear markets. The update above on this subject shows an example from the 2022 bear.
Major divergences are further apart in time, perhaps weeks to months. The example best illustrating a major divergence is the one occurring at the end of the 2000–2002 bear market. SPX made an interim low on July 24, 2002. On July 23-24, 2002, VIX made its highest high of that bear market around 48. Then, about 2.5 months later in early October 2002, SPX bottomed (final low). VIX made a lower high, diverging significantly. The divergence was significant in both time and in value difference, which made it a major divergence consistent with the actual low.
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