Technical Analysis—Short Term / Long Term Volatility ($VIX / $VXV)

Looking at short term volatility ($VIX) vs longer term volatility ($VXV), it "may" help you spot the bottom of stock price. For example, when the ratio ($VXV:$VIX) gets above 1 it seems to indicate a bottoming process.^[1]

What is a bottoming pattern?

A double bottom pattern is a technical analysis charting pattern. It describes the drop of a stock or index, a rebound, another drop to the same or similar level as the original drop, and finally another rebound.  As its name implies, the pattern is made up of two consecutive troughs that are roughly equal, with a moderate peak in-between.

Although there can be variations, the classic Double Bottom Reversal usually marks an intermediate or long-term change in trend. Many potential Double Bottom Reversals can form during a downtrend, but until key resistance is broken, a reversal cannot be confirmed. For more details, read [7].

Figure 1.  Relationship of $SPX and VXV:$VIX ratio (02/05/2021; Courtesy of stockchart.com)

$VXV / $VIX Ratio

The $VIX is the more widely known index, representing the implied volatility (IV) of S&P 500 options that expire in 30 days. The $VXV is the exact same index, except it represents IV for S&P 500 options that expire in 3 months.  The $VXV is usually higher than the $VIX, but not always.

Using the weekly chart (click to enlarge) of $VXV:$VIX ratio (dashed line) superimposed with SPY price (black line), the ratio seems to bottom before the price most of the time (see Figure 1).  

 

Figure 2.  Relationship of $VIX / $VXV / $VVIX and $SPX (Courtesy of stockcharts.com)

 

$VVIX

 

Options-implied volatility of U.S. equity prices is measured by the volatility index, $VIX. Options-implied volatility of volatility is measured by the volatility-of-volatility index, $VVIX. Importantly, these two are conceptually and empirically different sources of risk.^[8]

Computed from $VIX options in an analogous way to the $VIX, the volatility-of-volatility index ($VVIX) directly measures the risk-neutral expectations of the volatility of volatility in the financial markets. In the data, we find that the $VVIX has separate dynamics from the $VIX, so that fluctuations in volatility of volatility are not directly tied to movements in market volatility (see Figure 2).

There are some common prominent moves in both series, such as the peak during…the financial crisis. Notably, however, the $VVIX also peaks during other times of economic uncertainty, such as the summer of 2007 (quant meltdown, beginning of the subprime crisis), May 2010 (Eurozone debt crisis, flash crash), August 2011 (U.S. debt ceiling crisis), and August 2015 (sell-off driven by the Chinese stock market crash). The movements in $VIX during these events are far smaller than the spikes in the $VVIX. The suggests that the $VVIX captures important uncertainty-related risks in the aggregate market, distinct from the VIX itself.

Warning

As always, invest with your own research and risk.  Please do your own due diligence.

References

1. Rare Event Signals A Short-Term Trading Opportunity: Buy Stocks
2. VIX & VXV - Spread Chart and Quote - TradingView
3. Weakest Indices create reversal patterns at 5-year support
4. The VIX/VXV Ratio: A Quick Way To Review Volatility Contango
• Contango, a bearish pricing pattern that indicates ample near-term supply.
5. The VIX and the Stock Market
6. Double Bottom Definition - Investopedia
7. Double Bottom Reversal
8. The importance of volatility of volatility