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Market Volatility Explodes on Thursday. What Does That Mean For Friday?

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Volatility readings are through the roof, which could mean a bounce tomorrow.

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This article was originally posted on the Buzz & Banter where subscribers can follow over 30 professional traders as they share their ideas in real time.

In my last post, [subscription required], I mentioned today's 30% pop in the CBOE Short-term Volatility Index (VXST).

VXST was launched in January 2011 and is essentially the VIX' crazy cousin.

The VIX is based on expectations of 30-day future volatility, while the VXST is based on 9-day volatility, meaning it is far more sensitive to near-term market movements. (Steve Smith wrote about VXST here).

I ran a screen to see what happens in the S&P 500 and Russell 2000 the day after VXST rises by 20%, 25%, and 30%, respectively. Note: I ran the numbers with the VIX and 10%, 15%, and 20% pops, and they were in the same ballpark.

The time horizon for this study runs from January 4, 2011 (the day after VXST' inception) through yesterday.

On all trading days, the S&P and Russell both rose an average of 0.05%.

The average return on the day after the VXST popped 20% was +0.31% for the S&P 500 and +0.33% for the Russell 2000.

On the day after 30% pops in VXST, the average return for the S&P 500 was +0.48%, and the Russell's was +0.43%.

However, the number of up days did not appreciably increase following big pops in VXST.
 
But what's really interesting is that the size of the average up move increased substantially after those VXST pops. The excess return can be explained by the average up move expanding by a much larger degree than the average down move.

For example, the average up move on the S&P 500 on any given day was 0.65%. But the day after VXST rose by 20% or more, the average up move was 1.31%.

Only on 30%+ VXST pops did the average down move for the next day expand appreciably.

Here are tables with the data:





Twitter: @MichaelComeau

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