A Wild Summer for VIX and the Stock Market

August 31, 2011

This week’s COW takes a look at the Volatility Index (“VIX”), defined by the CBOE as the measure of short-term stock market volatility conveyed by S&P 500 option prices. It is also known as the “markets fear index”, as VIX tends to rise when markets are falling. Although the VIX has been extremely volatile since the Financial Crisis of 2008, we chronicle the events of the last two months in an effort to further illustrate the dramatic equity market movements of summer 2011.

Looking at the chart, we first notice the overall inverse relationship between the S&P 500 index (red line) and VIX (gray line); when one index is falling, the other is rising – not surprising, since we would expect market fear (as measured by the VIX) to increase when the equity market (S&P 500) is falling. Second, the month of July was relatively quiet, as neither index showed much movement over the course of the month. However, as August arrived, several events triggered substantial movements in the two indices. We focus on three of the most notable:

• On Monday, August 8^th, S&P downgraded the United States’ credit rating from AAA to AA+; VIX saw a 50% intraday gain from 32 to 48.

• On Thursday, August 18^th, VIX closed 35% higher than the previous day in the wake of more rumored problems for European banks, settling at 42.67 by end of day.

• Finally, August 24^th featured another large movement in the VIX index when it was announced that the CEO of Apple, Steve Jobs, was resigning due to health concerns. VIX quickly subsided though as markets expressed confidence in his successor to maintain Apple’s impressive run.

For the sake of comparison, the five-year average of the VIX index is 24.32; thus these elevated figures in August certainly reflect a higher than normal volatility, which has indeed played out in the equity markets. Although the figures do not approach the all-time high of 96.4 when markets were collapsing in October of 2008, the elevated levels have made investors stand up and take notice. Unfortunately, the VIX will likely continue to be volatile, which is a direct reflection of expected choppiness in the equity markets.