That Old VIX Magic

Regression your thing? Michael Stokes at MarketSci Blog looks into the thesis that much of what the VIX tells us, we already know. And concludes?

I am about 72% in agreement with a recent post from Mark Hulbert and follow up posts from (among others) the Daily Options Report and VIX and More. The VIX isn’t as magical as it might look at first glance. The reason is that so much of the VIX is comprised of information we already know.

Where does that 72% come from? Michael goes through all sorts of regression analysis (yes I know, I promised you there would be no math), He basically produces an "expected" VIX based on the price data, and an actual VIX and compares them. And finds.

That’s an 85% correlation (r-squared = 72%, hence why I’m 72% in agreement). By comparison, that’s about the same level of predictive ability the S&P 500 has in determining the value of the Nasdaq 100 (and that’s pretty darn high).

And his takeaway?

I disagree a slight bit with some previous posters. In the past, no matter how much I have tried to decompose the VIX into its building blocks, there was always an element of trader-driven unpredictability. I haven’t figured out how just yet, but I think that if we can isolate what that smaller subset of information is telling us, we might have something useful and unique.

And there's the rub. I can't parse his numbers, I retired from complex math over two decades ago when I switched majors from Math Science to something easy, Econ. But conceptually he sounds correct here. Not a stretch to say that 3/4's of the VIX can be explained from pure reaction to the price moves in S&P you already see.

Of that other quarter? Well, you have a certain amount of noise in the calculation. Perfectly normal anticipation of news events can pump up premiums, a holiday or summer doldrums can depress them, and I would suggest neither reflects all that much on the Fear Level this attempts to quantify.

So not sure how one would go about isolating that smidge of VIX we can't explain. Which is why I kind of prefer subjective analysis. Like right now, the VIX objectively looks low. We are not that far removed from some very real panic, yet it it sits in the very unexceptional low 20's. But is that so surprising? It's summer, we have Big Hank and Big Ben ready on the backstop, and it's highly likely we have a lull until the next bout of excitement.

So subjectively, I'd say right here, right now, I would not read much of anything into the VIX.

And remember, all mentions are sponsored by VIX Swimwear, "Yeah, just keep looking at those volatility charts"