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VIX to Hit a Trough


But will the VXX move with it?

Rob from Quantifiable Edges, Bill from VIX and More, and I had a little email conversation the other day regarding the VIX:VXV ratio.

To refresh, VXV is basically the VIX for normalized 90-day SPX options. So the thinking is that if the VIX gets too low relative to VXV, that's both bearish for the market (too complacent) and bullish for the VIX.

The data they run seems to bear that out. As the ratio relates to the SPX, it tends to work on Rob's system, though the duration of the trade is a bit long (it's a subscriber letter, so I don't want to give details of the exact system he uses). As it pertains to the VIX itself, it's almost perfect in that the VIX is always higher when the trade trigger closes. The issue, however, is that you can't actually trade the VIX -- only VXX or VIX futures -- and there's not enough history on either to see whether you'd win on that part of the trade.

Take now, for example. You'd have gotten the VIX:VXV signal (it went below .90) but VIX futures trade at a premium to the VIX (over 2 points now).

Anyway, here's my response:

I'm a little skeptical of VIX/VXV around a holiday. VIX should act weak when a significant chunk of the 30-day period is early summer and pre-holiday blahs. It's 10 calendar days right now until July 6. SPX traders will lower their bids ahead of anticipated slow trading stretches (remember -- real options have real time decay you need to offset). So it's overwhelmingly likely VIX will be higher in 10 days than it is now, and the VIX/VXV ratio will increase as VXV won't lift as much (10 days' decay isn't as meaningful in a 90-day option).

Is there a way to "game" that? Well, it has no predictive ability for the market between now and then, in my opinion. So VXX seems like the best vehicle. In normal circumstances, VXX will track about 40-50% of the VIX move -- but will it track it that well now? VXX represents a 30-day (hypothetical) VIX future. A VIX future itself just takes a snapshot of where the VIX will be on expiration day. A holiday between now and then has no impact. VIX July's (as I type) are about 29 -- a 2-plus premium to the VIX. So you'd first have to make that up before profiting on the VIX.

Now here's the kicker: I show July as the worst cycle of the year in terms of average and median VIX readings. But if I divide i into the first half and the second half of the cycle -- second half is always just the last 2 weeks; if it's a 5-week cycle, the first 3 weeks are defined as half -- it almost always lifts in the second half. This makes perfect sense given the holiday in the middle and then earnings season kicking in at the end.

So you're going to see the VIX trough pretty soon and then lift. Will the VXX lift with it? That I'm not as sure of.

Just to be clear, I'm only looking at market implications for the next week and change. After the holiday, it's high earnings season. Rob's numbers go way further than that.
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