VIX/VVIX Divergence before large drawdownsJust happened to be playing with a few things on tradingview today, thinking of new ways to identify trade opportunities. I often have to keep reminding myself to zoom out to see the bigger picture. This is one of those instances where I might have stumbled upon something useful for very long term trade trends.
As many know, VIX is an extremely useful indicator of market sentiment, it also signifies part of what makes up extrinsic value of options contracts. On the longer term time frame, you can see in a bull market volatility slowly compressing lower and lower. Lower highs, lower lows. Eventually, that trend starts to reverse as more and more large players maybe begin to take profits and go short, and more options hedging happen towards the downside.
VVIX is a further still derivative of that. It's the measure of volatility of volatility. What I did today was take VIX and divide it by VVIX and see what pattern emerged. At a glance, it's not far off VIX by itself, but, I did notice that weeks or even a couple months before a large market downmove, it gives a little more advance warning that a big sell off was imminent. A solid warning is the lowest low followed by two higher lows, as seen here:
If I instead plot VIX by itself, you see a double, maybe triple bottom at near enough the same low before you get a higher low. In the case of the second half of 2018, there actually wasn't an advanced warning at all:
But, what VIX by itself does show, that VIX/VVIX did not, is a lower high when the market found bottom in October/November 2022. VIX showed a lower high, VIX/VVIX shows the highest high at that point. So, always worth glancing at both on a long term chart if you're looking for very long term bets on the market and trying what normally is considered a fool's errand to call the tops and bottoms of every bear and bull cycle.
It might still be a fool's errand, but maybe this helps some of us get a little closer to being able to pull that off.
With that being said, we have just set a new low in both VIX and VIX/VVIX for the year, even though we just had a down week (6/20-23/2023), I'm not convinced we stay down for long until maybe I see such a pattern appear again with higher lows appearing in VIX/VVIX.
