Comparing the VIX with the S&P 500 Past Performance

While I don’t trade the VIX often because of my lack of Options trading experience, I do take a look at it every so often.

I thought now would be a good time to add a post comparing the VIX with the S&P 500 past performance as the VIX can be used as a good measure of the expected volatility of the stock market.

When market participants become fearful, they panic and sell, illustrated by a spike in the VIX.

On the opposite extreme, when participants are complacent, they typically have the majority of their funds at work in the market illustrated by a falling VIX.

Since the market has been on a roaring uptrend since March 2009, I’ll concentrate on looking for a sign of a top. Using the VIX again for the purpose of this post, if market participants are putting their money to work in the stock market buying many different stocks, we should be seeing a steady overall rise in the market with a falling VIX, or at least remaining low.

At or near a top in the stock market, I would expect to see a distribution process by market participants, selling more than they are buying and a rising VIX to illustrate some of this fear.

Since many individual investors continue to buy at the top of a market trend, some sort of plateau or gradual turning point, may be seen while looking at a chart over a longer time period. This is possibly due to larger traders and institutions beginning to unwind positions before the individual investors.

Once everyone catches on, look out below because that’s when all hell breaks loose and the VIX will display a spike on a chart.

Take a look at the charts I composed below for historical and current comparisons. The first chart is from the end of January 2009 thru yesterday November 11, 2009.

You can see on the chart above the clear uptrend in the S&P 500 with consistent higher lows in place. The VIX is displayed in blue on the chart. Noted on the chart from mid-April thru early August is a clear downtrend in the VIX with consistent lower highs made.

This goes along with what I mentioned at the beginning of this post that as more and more people put money to work and buy stocks, the stock market rises and the VIX declines as people become complacent.

From August thru today though, the VIX appears to be doing something different. As the stock market has continued to climb, the VIX has found a near term floor providing support and has been forming higher highs on pretty much each consecutive spike.

The VIX is showing how the Market is now climbing a wall of worry. People are getting fearful. Take a look at the next chart below now:

On this chart above I’ve added a few more observations.

• At areas (2) and (3), each time the VIX spiked, which also coincides with a sell off in the stock market on the chart, the spike in the VIX was followed up with a decline in it’s value as the S&P 500 resumed it’s uptrend.
• At areas (2) and (3), each time the S&P 500 made a new high, the VIX made a new low.
• At area (1), as the S&P 500 made a new high, the VIX did not make a new low. Instead, it made a higher low which was followed up with a spike in the VIX almost as if to relieve pressure that was building up.
• Area (4) is the current position. You can see that not only has the VIX made a higher low so far, the S&P 500 has not made a new high (worth mentioning here). The S&P 500 is currently showing a sign of possible distribution among larger investors/traders, being signaled by the pressure building up in the VIX.
• Notice the lower red dotted line which shows a relative base, or support level formed. Out of the last 4 lows to reach this level, only the most recent had fallen below this. Also notice the higher highs on each recent spike as mentioned on the previous chart also.

For some historical perspective, I added two more charts from prior time periods. The next chart below is from early March 2008 thru early June 2008.

You can see on the chart above that from late March thru mid-May, the S&P 500 made higher highs while the VIX made lower lows. Then, as the market started to roll over, the VIX began to rise as to be expected. This particular time was at the beginning of a major leg lower in the stock market.

The next chart is from early July 2008 thru early September 2008.

The same higher highs in the S&P 500 coincide with lower lows in the VIX. In this case though, the S&P 500 top flattened out and did not make a new high as the VIX began to rise, the same appearance as currently. This time period was also a major turning point that began a large leg down for the stock market.

The last chart above appears to be displaying a build up of pressure signaled by rising fear, as the S&P 500 tried but failed to make any significant new high.

Here’s a chart of the S&P 500 showing the two turning points coinciding with the last two charts above:

And here is a current chart of the VIX showing the base that appears to have formed with the recent spikes:

Based on my observations above, a trade using VIX CALL Options may be something to consider once you perform your own research and analysis. I’d be interested in what you think or have to say about this or other ideas. Let me know your thoughts below.