Should You Buy the VIX Spike?

by Chris Johnson | April 11, 2012 12:50 pm

The CBOE Volatility Index (NYSE:VIX[1]), better known as the “Fear Index,” has been trading higher over the last few weeks as investors are starting to feel as though the short-term market direction is due for a change. After touching below the 15 level in late March, the VIX has been trending higher as the S&P 500 Index (SPX[2]) has shifted away from its highs.

The last two days may change that though.

Over Monday and Tuesday’s trading, the VIX shot about 20% higher as the options market appears to be speculating that volatility is coming back into season. The 20% over two days is something that we consider unique enough that it warrants testing.

Looking back to 1990, there have only been 69 instances where the VIX spiked 20% over two trading days. A look at these 69 signals reveals that the S&P 500 usually encounters bullish market conditions over the following month of trading.

The table below displays the average performance for the S&P 500 after these spikes in volatility.

Screen Shot 2012 04 11 at 11.34.52 AM Should You Buy the VIX Spike? [3]

For the most part, these returns suggest we may be due for some short-term buying with the S&P 500 trading higher 60% of the time for an average of about 4% a month following these signals.

Those of us that watch the VIX know that some of these signals are likely to have been little more than short-term bounces that ultimately wound up reversing, but traders should still be able to navigate some profits from the short-term snap.
Screen Shot 2012 04 11 at 11.34.38 AM 300x190 Should You Buy the VIX Spike?
Click to Enlarge

The catch, because there’s always a catch… 

Tuesday’s trading took the S&P 500 below its 50-day moving average, making it the third of the four major indices to close below its respective 50-day trendline. The Nasdaq Composite (COMP[4]) is the only one that has remained above its 50-day.

We view, as does much of the market, the 50-day moving average as the best barometer of intermediate-term technical health.  So the catch is that we need to see the S&P 500 move back above its 50-day moving average, currently sitting at 1,373, to confirm the bullish VIX signal.  We expect to see this confirmation or rejection over the next two days, so get your trades ready.

As of this writing, Chris Johnson does not own any securities mentioned here.

Endnotes:
  1. VIX: http://studio-5.financialcontent.com/investplace/quote?Symbol=VIX
  2. SPX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPX
  3. [Image]: http://investorplace.com/wp-content/uploads/2012/04/Screen-Shot-2012-04-11-at-11.34.52-AM.png
  4. COMP: http://studio-5.financialcontent.com/investplace/quote?Symbol=COMP

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