I was very pleased to see my inbox flooded with questions today about what the heck happened in the markets yesterday.  It’s great that so many of you are following the day to day market action and taking an active interest in investing.

So yes, quite a bizarre day yesterday.  Take a look at this:


Ok what…?  Isn’t the VIX index supposed to go down when markets are up that much?  Isn’t the XIV supposed to have a good day when the markets storm higher?  And actually intraday the VIX Index was up as much as 12.62% yesterday.  How is it possible the VIX could be up that much when the S&P and Dow were having such a great day from start to finish?

Answer:  The VIX Index isn’t actually directional

The VIX is calculated using a wide variety of implied volatilities of S&P 500 options to measure expected forward 30-day volatility.

It does not imply any direction, only magnitude.

This means that it’s possible to see the VIX Index go up when stocks go up, and vice versa.  The VIX index can also go down when stocks go down.  It’s not what I would call the norm, but it’s not that uncommon.

–  Yesterday the VIX closed at 11.28.  What does this mean?


The VIX Index measures one standard deviation of the markets 30-day expectation of S&P 500 price changes.  
In order to turn this into a daily expectation we divide by the square root of the number of trading days in a year which is about 252.  The square root of 252 is 15.87.


11.28  /  15.87  =  0.71


A VIX of 11.28 means the options market is pricing in forward daily S&P 500 moves of 0.71% within one standard deviation or 68% of the time.  32% of the time it’s implying a larger move.


Notice how I haven’t mentioned direction anywhere?  That’s because the VIX doesn’t imply direction, only magnitude.  Maybe these 0.71% daily expected changes are down, or maybe they’re up.

So despite quite a few tweets I saw yesterday to the contrary, the VIX Index isn’t broken and this doesn’t signal any kind of volatility regime change.

More than likely this is just due to the upcoming US Senate vote on the tax bill.  If it fails it’s certainly possible markets will go down on the perception of bad news.  If it passes, perhaps equities will continue to rise.

Either way, it’s normal for the VIX to rise heading into a major binary event so the VIX being up over 5% yesterday seems normal.  In my opinion the outlier is that the S&P actually rose nearly 1%.  Usually markets stay pretty flat heading into events, but yesterday there were clearly a lot of front running buyers.

But yes the VIX sometimes does go up when stocks go up.  I’ll continue this article next week and show some interesting data on VIX correlations as well as how common / rare it is to see the VIX and the S&P rise and fall together, and by how much.

Have a great weekend!


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