Bill Luby writes about the near portion of the volatility curve 30 days (VIX) to 90 days out (VXV) in VixAndMore:
ZeroHedge in his never ending quest to prove the market will go lower posted that the VIX:VXV ratio has hit a 2009 low. And he’s correct, it has hit a low.
To refresh, VXV is the same as VIX, but for 90 day options. So it’s a look at longer term volatility assumptions. The thinking is that if the ratio gets out of whack, the VIX will “revert” to the VXV. Thus when the ratio is low, the VIX should revert up.
And it should, but I would suggest that all that means right now is that near term options are pricing in a very slow stretch the next couple weeks. It has very little predictive value right now as to where the market will go next.
Check out the top graph, the VIX:VXV ratio for as long as they have quantified the VXV. Notice something about every trough? It’s almost always a slow pre-holiday stretch.
Check out the last week of 2007, Memorial Day and Labor Day 2008, end of year 2008, et. al. It correlates better to that than actual market moves (chart below is SPY over the same time frame. Notice also a disastrously bad “high” ratio signal last September/October. Turns here have great predictive value if you are in the dark about our federal holiday schedule. Not so much for the SPX.
I’m not saying there’s no utility watching this relationship. Volatility after all is mean reverting. You just have to keep in mind that often “mean revert” is nothing more than a “calender revert”. And I would suggest that’s exactly what we are seeing right now, a window of time that is the single worst stretch for the VIX itself.
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