Traditional trading strategies use the CBOE Volatility Index, or the VIX, to help pinpoint upcoming moves in the S&P 500 Index, known as the SPX. This always seemed to be a somewhat operating theory as, logically, one would think that the implied volatility precedes market volatility movements, given the perceived role of the VIX as a “fear index.” Perhaps it’s the opposite that’s correct instead.
The Platform: A recent study, titled “Chicken and Egg: Should You Use the VIX to Time the SPX or Use the SPX to Time the VIX” by Robert Hannah, challenges this traditional relationship. The study looks at the VIX-SPX relationship and finds evidence that the SPX may be a more useful predictor of the VIX’s future direction.
My paper consequently argues that the focus should shift towards SPX-based analysis, which would give better information about market volatility than reliance on the VIX would. This shift in perspective will have major implications for traders and investment strategies.
Key Results of the Study
The research paper by Robert Hannah will explain the much-quoted relationship of the VIX with that of the SPX with particular emphasis on the latter’s market volatility and future trends prediction.
Key Insights:
Traditional Use of VIX in Market Timing
Traditional Use of VIX in Market Timing
Traditionally, investors and traders have used the VIX as a leading indicator for the direction of the SPX. The inverse relationship comes from the idea that when VIX is high, this is an indication of fear and therefore a low S&P 500; whereas a low VIX suggests a stable or a bull market.
Re-examining the Relationship Between VIX and SPX
The findings of this study may indicate that the conventional usage is off the mark. It is possible that the SPX movements are more reliable indications about future directions of the VIX from both historical data and a set of volatility measures rather than the VIX serving that function for the SPX.
SPX as a Predictor of VIX
The study has also consistently shown that SPX readings—such as short-term RSI readings and high-low metrics—are generally better predictors of future VIX movements. This finding flips the usual framework, suggesting that traders should focus more on SPX trends when attempting to predict market volatility.
VIX-Based Securities Incorporation
Also explored in the paper is an exploration of the possible utilitarian aspect of including the securities built off the VIX in the portfolios, such as the VIX Futures and ETFs. The study then observed their robust downside persistency in response to financial crises, thus presenting excellent instruments for managing volatility on days of turbulence.
Implications to Traders and Investors
The results of this paper indicate the need for a shift in focus away from VIX-centric to SPX-centric analysis, with a particular emphasis on forecasting and maneuvering market volatility. The study questioned the traditional reliance on the VIX as a leading indicator and instead suggested that movement in the SPX probably provides better predictive signals.
Key Takeaways:
SPX-based Analysis:
By the study, it is found that SPX movements are far more reliable in predicting the future trend in VIX rather than vice-versa.
Pay more attention to the market indicators:
Traders are more likely to be better informed about tendencies in volatility with measures like RSI and high-low readings of the SPX.
Add VIX-based Securities:
Another strategy might be for traders to incorporate VIX Futures or ETFs into their portfolios during market declines or crises.
Conclusion
The study of Robert Hannah throws new light on the understanding of the relationship between VIX and SPX. It was stated that this might probably be achieved when the movement of SPX was used to better predict volatility. Such a shift in approach can afford traders and investment managers with an efficient platform for making prudent decisions when the markets go into overdrive. For a deeper dive into this research, check out the full paper linked in the description below. Be sure to like, subscribe, and comment if you’d like more insights into similar topics! Happy trading!