Wednesday, June 2, 2010
An Historical Perspective on Volatility Spikes
This past month has produced a rare event: a spike in the VIX of more than 40%. While I was aware that this was unusual, I wasn't sure how unusual until I started playing with the numbers. As it turns out, there have only been 10 such events since January of 1990 when records for the VIX began. So let's take a walk down memory lane.
The VIX spikes 47% during the month as concerns about the economy mount. The first George Bush was beginning his second year in office and for those of you who follow election cycles and its impact on the markets, the second year in office has the worst record historically. The S&P 500 (SPX) found a temporary bottom approximately 5% below its 200-day simple moving average (SMA) near the end of January and moved higher into the summer. The SPX put in a double top in June and July of 1990 before plunging from mid-summer into the fall.
The VIX spikes 41% after moving 36% higher in July as the SPX dropped 20% from its July high until its October low, finally bottoming 12% below its 200 day SMA. Economic woes continued to mount as the second year of the election cycle led the market down roughly 7% for the year.
There is a long break in extreme moves as the market began a solid multi-year advance.
1996 was shaping up to be a decent year, until the SPX dipped 5% in July and the VIX jumped more than 42%. This began a month long battle with the 200 day SMA before the SPX resumed its climb finishing the year up 20%. Oh and for those too young to remember, health care debate was coming to a close as Congress passes HIPAA, the Health Insurance Portability and Accountability Act protecting coverage for workers and families when they lose or change jobs. Additionally, the rupee was struggling as a Javanese earthquake shook the region, but the distressed currency may have been a precursor to the all out crisis in 1997.
The Asian currency crisis is in full swing and the SPX falls as much as 13% during the month as the VIX leaps 53%. Once again, the index found intraday support around its 200-day SMA. But nothing could hamper the go-go '90s as the market tacked on more than 30% for the year.
Long Term Capital Management requires a Federal bailout as its volatility and currency bets spiral out of control. The VIX soared a then record 78% over the month as the SPX plunged from a 14% premium to its 200-day SMA to a 9% discount. During the month of September 1998 the index returned to test the average before setting a double bottom and finishing the year strong. The '90s were unstoppable with the market tacking on another 28% for the year.
Interestingly, as the internet bubble burst and we moved through the 2000-2003 bear market there were no month over month volatility spikes greater than 28%.
By the end of May 2006, the SPX was in negative territory for the year and the jumped more than 41% setting off a summer long back and forth battle with the 200-day SMA. Although the Iraq war was in full swing and the infractions at Guantanamo Bay were coming to light, there was little headline financial news to send the markets into turmoil. By the end of the summer, not only had the SPX regained positive territory, but it began a move that would but it up 13% for the year.
The real estate cookie was beginning to crumble, durable goods orders were declining, and China's growth was in question. The VIX leapt nearly 48% on the month mostly driven by a 4.1% disaster of a day on the 26th which constituted the largest one-day point decline for the Dow Industrials since 2001. But there were still plenty of late comers who wanted in and the SPX found support around the 1380 level before moving to its peak later in the year.
The VIX jumped by 45% after moving up 24% in June. Sub-prime mortgages were collapsing and John Paulson was making a mint. Although the July high for the SPX was not the ultimate high, we had to wait for October 2007 for that, it was the first of a double top from which the markets have yet to fully recover.
September – October 2008
The only time in the 20 year history of the VIX that it increased by more than 40% in two consecutive months. The 90% record one month spike in September was followed by a 52% jump in October. But let's face it, the world was coming to an end. No one knew if the US would have a financial system left and the poorly worded TARP legislation was little comfort. The SPX plunged nearly 50% in a scant two months; even the bursting of internet bubble caused less short term damage. Additionally, after this spike occurred the time to the March 2009 low was the longest before the market found at least a temporary bottom.
The VIX jumped 45% last month preceded by a 25% move in April. Two consecutive months with greater than a 20% month over month move in volatility have occurred 5 times including the most recent. In the prior 4 instances the VIX has been roughly 10% lower 2 months later while the S&P 500 has gained less than 1% over the same 2 month period.
Even when the spikes are relatively isolated, the SPX has taken a month or two to find new direction.
The conclusion today is that there is some historical suggestion that selling volatility out into July may be the preferred move, albeit from a very small sample size. With the Average True Range (20) of the SPX at the highest level since December 2008, there is certainly some room for volatility to come in. However, there are a number of exogenous factors that could tip the markets. Foremost on my mind, is the devastation that an early season hurricane could wreak on the Gulf Coast including the western coast of Florida, depending on trajectory. I don't believe that the economic impact of the oil spill has been fully priced into the market, but that may take time. The same goes for the as yet unresolved European debt issues and the overall state of the US economy. But the bottom line is that although intraday volatility may not be going away, the current battle with the SPX 200-day SMA is likely to continue into the middle of the summer, so if you have stock positions, long or short, that you have been waiting to sell options against, now may be a good time to do it.