The VIX Finally Popped as Market Pooped

by CC August 4, 2011 5:20 pm • Commentary

I was watching curiously the past couple of days as the market’s bloodbath was seemingly being ignored in the VIX. Sure it was higher but not nearly what it should have been considering the ongoing bloodbath in stocks. Today that changed. The VIX had a huge pop, particularly towards the end of the trading session as the market’s decline accelerated into the close, it closed up 35% on the day. XIV, which tracks the VIX futures was down nearly 20%.

As I mentioned on Quick Hits, right before the close, I am adding to my XIV (more on XIV here) position at these levels. I like levels in the VIX when it pops above 30. Historically above 30 in the VIX is where one can start getting serious about being short vol. Like I said earlier, you always want to save bullets. It’s not uncommon for the VIX to go even higher if this selloff were to continue. Look at the chart below:


Apart from real Armageddon situations (like the banking crisis in ’08) the VIX tends to rocket up intraday at or near bottoms in the market. At those moments it tends to reach between 30 and 40 before reversing. The reversals are usually pretty hard, just like the explosions that gets it up to those levels.

Barring some really effective Central Banks’ intervention, it seems like we may be in for a sustained period of higher volatility. That’s why you want to pick your spots in a product like this. This needs to be money in your trading account that you’re willing to to take the risk that you are early… but remember, volatility is mean reverting, when the market stops going down by 3, 4 or like today nearly 5 percentage points intraday, the VIX will come in. When you are shorting the VIX (in this case by buying XIV) you are making a bet that volatility will come in (it will), but you have no control over when that will happen. If the market reverses tomorrow, the VIX will come in from 32 to something more in the mid to high 20’s. If this was your opening trade in XIV, and you don’t think the volatility is done with, you may want to take your profits on that kind of move.

Last Summer’s downward move in the market, which was about a 16% correction, drove the VIX into the 40’s initially. The VIX then came in to 25 almost immediately, only to resume its pop higher to the high 40’s. That second pop then reversed and came back to 25, then popped again to 35 before going down for good, taking about 5-6 months until it was back below 20. See chart below from last summer:

We could be in for a volatile period like that and it could last for a while. So the way I will play this is to take my profits on at least part of my position on those reversals off highs (usually corresponding with relief rallies in the market). That way I can stay nimble and keep bullets if there are more ridiculous moves higher like last summer.