The VIX as an indicator

A hackneyed phrase is that investors oscillate between fear and greed. When one emotion gets too powerful relative to the other, stock markets become volatile places. There now exists a method that some believe is a gauge of the collective fear among equity investors. This mirror into the collective soul of the investing public is called the VIX. VIX is actually the ticker symbol assigned to the Chicago Board Options Exchange Volatility Index. It measures the expectation of traders as to the volatility of the S&P 500 over the next 30 days. The higher (lower) the VIX the more (less) volatility that is expected.

Since the VIX was introduced in the 1990s, there have been a number of periods where the index has spiked upward. Typically, this has happened after periods of poor performance. The question we asked was: "How does the stock market perform after a period where the VIX has been at unusually high levels?" Let's first focus on days when the VIX has been above 30. In the four weeks after those periods, the S&P 500 index has been up 4% on average and up 22% in the one year after the VIX has been at that high a level. What's more interesting is that, if we restrict our focus even further to just those days when the index was 35 or higher, the subsequent upward has been, on average even higher whether we're looking at four-week or one-year periods. Finally, on rare occasions, the VIX breaches 40. This has tended to be an even more positive development for stocks in the past. Where are we now? The VIX closed at 69.95 on October 10.