Macro Wrap – $VIX Instability First, Market Instability Later

by Enis April 16, 2013 7:58 am • Commentary

In the past 2 months, we have experienced 2 of the largest percentage moves in the VIX in the product’s history.  Considering that’s more than 2 decades of data, that’s some extreme movement.  Perhaps more incredibly, they’ve taken place with the SPX index at or near all-time highs.  Not in a market that is in any type of outright panic.

To put these moves into context, I wanted to look at how VIX volatility compared to SPX volatility over time.  First, here’s the visual comparison of realized volatility in the VIX (black line) vs. realized volatility (orange line) in the SPX over the last 2 years:

50 day VIX realized volatility (black) vs. 50 day SPX realized volatility (orange), Courtesy of Bloomberg
50 day VIX realized volatility (black) vs. 50 day SPX realized volatility (orange), Courtesy of Bloomberg


What to make of this picture?

Normally, the volatility of the VIX is closely correlated to the volatility of the SPX.  At the end of the day, since the VIX is a measure of SPX volatility, that correlation makes sense.  The VIX is unlikely to move as much when the SPX is not moving much.  In 2013 though, we have seen a serious change in behavior.  The realized volatility of the VIX has been trending higher over the course of the year, while the realized volatility of the SPX has been flat to lower in 2013 (despite yesterday’s move).

So traders in VIX products are much jumpier than traders in the broader SPX index.  If we look at the ratio of VIX 50 day realized volatility vs. SPX 50 day realized volatility over the last 10 years, the only previous instance where the ratio got this high was in early 2007.  That was also the beginning of a 6 month topping process that eventually led to a bear market.

Spikes in VIX volatility are sending warning signals about market instability.  It is only one preliminary warning signal in a longer-term story.  Two 40%+ spikes in VIX spot are too rare an occurrence to assign too much value.  But I do expect higher SPX volatility over the rest of 2013 based on this recent VIX action.  History does not repeat, but it does rhyme.