Relation between VIX, S&P500 and the CDX-Index

The VIX-index is a measure of implied volatility in the S&P 500 and is often referred to as a fear index.  CDX.NA.IG is a credit default swap-index consisting of 125 North American investment grade companies and the S&P 500 is a stock index consisting of the 500 largest companies in USA.

In [1], authors use ordinary least square (OLS) regression to study if VIX can be explained by CDS and S&P 500. and find that the VIX, CDX.NA.IG (will be referred as CDX in this article for short) and S&P 500 have a high correlation.

Figure 1.  A mean-reverting pattern of inverse relationship of VIX and S&P 500 played out cleanly in 2022.

VIX

VIX is measured as the weighted 30-day implied standard derivation of annual changes in S&P 500.  For example if the value of VIX is 20, then S&P 500 is expected to increase or decrease by 20% over the next year.^[2]  This will be true in 68% of the cases, because standard deviation is in this case assumed to come from a normally distributed random variable, where 68% of the outcomes lies within one standard derivation fro  its mean.

Values of VIX above 30 are often observed in distressed markets while values below 30 are associated with calm periods.^[3]

On 12/08/2022, Yahoo Finance has also published a similar observation from Jared Blikre.  Here is the gist of it:

• Sell at 20 and buy at 35 are retro-fitted thresholds in the VIX for year 2022
• It took about six weeks for the VIX to travel from 20 to 35 the last go-around
• Also monitor the below developments for more clarity:
• S&P 500 could flash a bullish signal by simply reclaiming its 200-day moving average to the upside.   This would likely (but not necessarily) occur in confluence with a simultaneous close over its 2022 negative trend line (the red line in the first chart), which would strengthen the signal.
• The U.S. dollar could also add clarity 
• Note that a strong dollar tightens financial conditions, which generally weighs on risk markets and commodities.

CDX.NA.IG

CDX stands for Credit Default Swap which is a credit derivative used to hedge the risk against a credit event such as a default on a bond issued by a company, it can be seen as insurance on credit loss.

By studying CDX, we get a sense of the credit risk associated by the companies.  The CDX indexes are broken out between investment grade (IG), high yield (HY), high volatility (HVOL), crossover (XO) and emerging market (EM).

CDX.NA.IG indices are comprised of 125 North American corporate credits that are Investment Grade when the index begins trading. Taking a position in the index allows traders to hedge or speculate.  Note that the 125 companies in CDX.NA.IG are also included in S&P 500.

Figure 2. A historical price chart of VIX and CDX.

Figure 3.  Current price chart of VIX and CDX.

Figure 4.  Current price chart of inverse VIX and S&P 500.

VIX and CDX

In Figure 2&3, we have shown a historical and a current price chart of VIX and CDX and, in Figure 4,  a current price chart of inverse VIX and S&P 500.

In [1], the authors has concluded that:

There is a strong positive correlation between VIX and CDX.NA.IG as well as a strong negative relationship between VIX and S&P 500.

Why we need to monitor both $VIX and CDX.NA.IG?  Alastair Williamson on Twitter has suggested that (01/04/2019):

With CDX NA IG coming back in, this is supportive of a bear market rally in the stock market, but the moment when spread widens again, that should be the top of the bear market rally

Once $VIX & CDX NA IG find meaningful unfair lows - that should mark the top of the bear market rally in the stock market 

References

1. A study on the relation between VIX, S&P500 and the CDX-index
2. Williams, M. (2013).  VIX: What Is It, What Does It Mean, And How To Use It.  Seeking Alpha
3. Oeoutibem H, (2011).  Runnin' scared: VIX fear gauge spkies 35%. CNN
4. The dollar holds the key to a burgeoning bull run in stocks: Morning Brief
5. Why stock bulls are sitting on their hands again: Morning Brief