Volatility Regime Change and our Volatility Barometer

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The Great Volatility Regime Change  -  Part 1

Some of you have no doubt heard me on our livestreams refer to what I call "The Great Volatility Regime Change."  If not, tune in live on Friday's and it won't be long before you're familiar with the name.

Essentially, since I launched VTS all the way back in January 2012 and since then there have been two distinct Volatility regimes in the market with that punctuated change happening on exactly February 5th, 2018.  Why is that day relevant?  In a word, Volpocalypse!

25 largest single day VIX % moves since 1990:

On February 5th, 2018 the VIX index spiked up 115.6% which was the largest Volatility spike in nearly 40 years going back to the Black Monday stock market crash of 1987.  Due to the severity of the crisis, the Volatility ETP complex saw radical changes.

Most notably, the old king of the inverse Volatility trade XIV was terminated due to the -96% single day loss.  The ETFs called VMIN and VMAX were also delisted shortly afterwards.  The SVXY was deleveraged from -1x to -0.5x.  The UVXY was deleveraged from 2x to 1.5x.  Also, the underlying SPVIXSTR index that most of the front month VIX future ETFs track on a daily basis underwent major improvements as well to ensure something like that wouldn't happen again.  It was a very significant event to say the least.  Here's a video if you want more information about that day and why I'm not so worried about it happening again:

Click for video:  What caused Volpocalypse?

There's several different ways we can quantify the Volatility regime change, and there's definitely something to learn in each of them so we'll break them down one at a a time in a series of articles.

Part 1:  Our VTS Volatility Barometer marks the change

Any single Volatility metric like the VIX index, the VIX futures, the Volatility Risk Premium, etc, can be unreliable and give a lot of mixed signals.  The centerpiece of my work is our Volatility Barometer which currently takes information from 13 different Volatility metrics and combines it into a single value which is the best representation of overall market Volatility.

Click for video:  VTS Volatility Barometer

Given that the Volatility Barometer is using some data that was only available since 2006, and I do require 5 years of data to be able to rank the percentile values, the official inception date for the barometer is January 2011.  Those daily values can be plotted on a chart just like any other index.

VTS Volatility Barometer since inception in January 2011:

It can be a little messy on a long-term chart which is why in every daily email to VTS subscribers I also show it over 1 year and 3 year periods.  Another thing I add to it is a green section marking the lowest 1/3 of readings and a red section marketing the highest 1/3 of readings.  This makes it far easier to see what level of Volatility the market is currently trading in, which will inform how aggressive or conservative our trade positions for each strategy will be.

VTS Volatility Barometer in the last 1 year:

Visualizing the Great Volatility Regime Change

Since inception in January 2011, the long-term average for the Volatility Barometer is 46.62%.  It makes sense that it's a little below 50% given that it has mostly been a bull market since 2011. 

Now of course there have been some very pronounced Volatility spikes as well to bring up the average.  Not only Volpocalyse but also the 2020 Pandemic, the Q4 2018 market crash, the 2015 China hard landing, the 2011 European Debt Crisis, etc. 

Volatility Barometer Long-term average:  46.62%

Before and after February 5th, 2018 Volpocalypse

It's quite convenient that the dividing day of Volpocalypse gives us 7 years before and 7 years after, so the values can accurately be compared to see if there really is a Volatility regime change.

The way I create the Volatility Barometer mathematically, it's never going to hit 100% or 0%.  The lowest it's been is around 13% and the highest values are just barely over 90%.

The 7 years before Volpocalypse average:  39.94%

The 7 years since Volpocalypse average:  53.31%

This is a huge difference when viewed through the lens of trading strategies and it means we've spent significantly more time in safety positions compared to many years ago.  Trends where the market stays calm for several months are happening more rarely than before.  

The playbook the last several years has been to get into aggressive positions when we can, make our profit when it's available, and get the heck out to safety when Volatility tells us to because at some point this economy is going to completely fall off a cliff.

Buy the dip works, until it really doesn't, and then look out below!

Volatility ebbs and flows 

I have no doubt that things will eventually revert back to the mean, and well below the mean, that's how markets behave long-term.  Just because we've been in a higher Volatility regime the last several years doesn't mean it will always be this way.  In part 3 of this mini series I'll show that there have actually been 4 different Volatility regimes in the last 20 years, dating back well before the Financial Crisis.

To be continued...