Fisher Investments Editorial Staff
Alternative Investments

What Does VIX^2 Equal?

By, 03/15/2012

The Chicago Board Options Exchange announced Tuesday a new benchmark index—the VVIX, or the VIX of VIX Index. As the name might imply, the new index will track the volatility of … volatility.

But before we get to the VVIX, consider what the VIX is: It aims to track the market’s expectations of 30-day volatility for the S&P 500. Typically, VIX watchers interpret a high VIX as a sign investors are exceedingly fearful—signaling a good time to buy—and a very low point means a worrisome lack of fear and a good time to sell. Hence the saying, “When the VIX is high, it’s time to buy. When the VIX is low, it’s time to go.” After all, a wise man once said we should be greedy when others are fearful and fearful when others are greedy. So an “extreme fear” index might seem useful.

Except the history of the VIX tells us it’s not a reliable buy (or sell) indicator. First, if you plot the VIX against volatile periods of the S&P 500, there can be a strong negative relationship—meaning low-VIX points did signal good times to buy and the reverse. However, the relationship is coincidental and relative. Meaning VIX peaks and troughs happen at different index levels, and you have no idea an inflection point happened until after the fact. Then, too, you’d have to know ahead of time you were entering a period of heightened volatility. Often, strong stock returns happen against a backdrop of a fairly low and stable VIX. So for all the times the VIX may work nicely (and you have a crystal ball and can know a peak or trough has formed), there are likely as many situations in which it doesn’t tell investors much that’s very useful.

Already, if the VIX isn’t useful as a forward-looking indicator, you know the VVIX (or the VVVIX, or the VVVVVVVVVVVVIX—can you imagine this product development meeting? “Guys … there are, like, A MILLION products here!”) probably isn’t so useful. When the VVIX is high, it’s time to … buy … what, exactly?

Now, the VVIX will measure the market’s expectations of the market’s expectations of 30-day S&P 500 volatility. (And everyone knows you can’t triple stamp a double stamp!) So if you are watching the VVIX, what is it you’re trying to time the purchase of? The VIX itself? Keep in mind, the VIX doesn’t appreciate. It generally fluctuates around a mean (and the VVIX will, too). It’s not a buy-and-hold game. Volatility isn’t an asset class—it’s the description of the movement of an asset class. And the VVIX is, evidently, the square root of the description of the movement of an asset class.

Then, too, sentiment (which the VIX is arguably one somewhat flawed measure of) is just one consideration when shaping forward-looking expectations. What about equally important economic and political drivers? And both the VIX and the VVIX are US-focused. What about global markets? The US represents only a quarter or so of the global economy and less than half the equity markets. Investors should consider global factors. (Hey—maybe someone will come up with a European VVIX, too! Diversification!)

We applaud constant innovation in financial markets—and indeed, there may be some useful observations to be gleaned from watching the VVIX. But VIX, VVIX or VVVVVVVIX, be cautious of presuming any one indicator is the silver bullet to market forecasting.

 

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.