Remember the daily record advances in the S&P 500 back in January of this year. Remember the VIX rising alongside such advances as the RSI hit record levels during this time period. Investors enjoy or appreciate when the S&P 500 breaks out and to the upside with strength and breadth, as it did back then and is doing presently. But that appreciation doesn’t come without some level of fear and consideration that daily record high advances don’t come without an inevitable mean reversion. In other words, all good things must come to an end, even if only for the moment. Again, we saw this back in January, record highs daily and record highs that inevitably led to a 12% correction for the S&P 500 through much of February and into March. The consequence: a VIX that rocketed from 10% to over 50% in very short order and with a 100%+ gain for the VIX in a single day.
The S&P 500 finished at a record for the third session in a row Tuesday while the VIX also rose to 12.50 and for a second consecutive day. The VIX tends to trade inversely to the S&P 500 some 87% of the time. The VIX is a measure of the market’s expectation for volatility over the next 30 days and is calculated from the implied volatility of S&P 500 options. A low reading indicates a calm market while a higher reading/number suggests elevated uncertainty/fear. All indicating terms are relative of course, unless you are directly trading VIX derivatives and don’t care for “relatives”.
When anomalistic trading of the VIX complex comes to bear, it forces upon VIX traders to discover the reason for the trading activity. There are a number of indicators to review how premiums in the complex are being traded with regards to assigning risk. The majority of the time, the vast majority of the time, VIX futures are traded net short. VIX futures determine the shape of Term Structure or the VIX futures curve, as it is known. In order to better understand the volatility risk premium and Term Structure we can look at how Non-commercial VIX traders are positioned. I outlined to Finom Group (for whom I am employed) subscribers last weekend, in our weekly research report, the following:
