Prior to the relatively steep September 9, 2016 market decline, it had been 43 consecutive days since the last time the S&P 500 lost more than 1% in a single session.1 Volatility spiked roughly 40% on the day, according to the CBOE Volatility Index® (VIX®), or the “investor fear gauge” as it is known informally.
If you monitor market volatility, you probably know that it was relatively low for most of this past summer. After the spike higher caused by the June 23 Brexit vote, the VIX receded and remained below 16—until recently (see the chart below).
The VIX is a popular volatility benchmark that many active investors utilize, but there are several other measures recently introduced that also evaluate market volatility. The latest of these measures is SPYIX, an index introduced by Bats Global Markets (Bats), and it has garnered some interest among volatility watchers due to the unique way that it attempts to measure market volatility. If you think that measures of volatility expectations have predictive value, which ones should you consider using?
What are the VIX and SPYIX?
The VIX, created by the Chicago Board Options Exchange (CBOE) in 1993, seeks to measure investors’ near-term (30-day) expectations about stock market volatility, based on real-time prices of options on the S&P 500® Index (SPX).
Historically, the VIX has had a strong, inverse relationship with the S&P 500. From 1990 to 2013, the annual correlation between the VIX and the S&P 500 was -0.788, and that negative correlation was slightly greater (-0.839) from 2004 to 2013.2 As the accompanying chart illustrates, investors typically expect volatility to increase (as measured by the VIX) when the market is under pressure. Alternatively, when the market is doing well, investors typically expect volatility to decrease.
Like the VIX, the recently created Bats-T3 SPY Volatility Index (SPYIX) is a measure of investors’ near-term volatility expectations. The performance of SPYIX has been mostly similar to that of the VIX. However, SPYIX is calculated differently, yielding slightly different results that can be observed between the two volatility measures (more about this later).
While the VIX is calculated using SPX options, the “Spikes” (as SPYIX is sometimes referred to) is constructed using options on the SPDR S&P 500 ETF (SPY). SPY attempts to track the performance of the S&P 500 Index; it is the world’s most actively traded security, and options associated with SPY represent roughly half the $100 billion traded per day across all U.S. equity (i.e., stock) options.3
VIX, SPYIX, or both?
Bats Global Markets, a global exchange operator, developed SPYIX believing that it provides a more accurate view of market volatility versus other volatility benchmarks. According to Bats:
- SPY options more quickly reflect volatility expectations as implied by SPY options, compared with that reflected by SPX options.
- SPYIX’s methodology has a smoothing effect on erratic intraday price swings in option prices.
- SPYIX’s methodology is familiar to traders and compatible with the existing active market in volatility options, futures, and exchange-traded products.
Does this mean you should use SPYIX instead of VIX? Not necessarily.
A major advantage of the VIX is that it has been around for more than three decades, and so there is a fair amount of historical performance to assess its ability to measure volatility. Alternatively, SPYIX was introduced in May 2016.
How accurate has the VIX been? Dr. Robert Whaley, professor at Vanderbilt University, recipient of the options industry’s William F. Sharpe Lifetime Achievement Award, and co-creator of the VIX, analyzed VIX’s historical data and found that it tends to overstate actual volatility by about 4%.4 He deems this a relatively small margin of error, concluding that the VIX has done a relatively good job over time of measuring short-term volatility expectations.
There is another factor to consider when comparing VIX and SPYIX. It has been observed that SPYIX tends to exhibit marginally larger spikes during periods of heightened volatility, compared with the VIX.4 Whaley attributes this discrepancy, in part, to regular options investors’ tendency to buy SPY options (which is what the SPYIX is based on), while large institutional investors typically utilize SPX options (which are the options used to calculate the VIX).
In Whaley’s view, SPYIX’s tending to be more sensitive (e.g., producing larger price moves)—particularly during bearish markets—is due to retail investors propensity to react with a greater sense of fear than professional asset managers. Consequently, there may be a benefit from assessing both fear measures to see how the two groups of investors are responding to market volatility. However, given SPYIX's relatively short track record, there may not be enough information yet to determine how it will perform versus the VIX over the long term.
Other ways to measure volatility
Whaley cautions investors against misreading the implications of the VIX, or any volatility measure, for that matter. “Many investors don't understand [the VIX] fully; they think… if it gets too high a level, a stock market crash is going to happen,” Whaley says. “Dispelling them of that notion is a little difficult sometimes.”5
Instead, the VIX, SPYIX, and other volatility measures can be thought of as useful tools that, when viewed through their appropriate lens, and when combined with other fundamental and technical data points, can help form a comprehensive assessment of market volatility. Analyzing potential market volatility can be particularly useful for a variety of strategies, including many options strategies that depend on how volatile an underlying security is expected to be.
It’s important to recognize that these two indexes are only useful for assessing short-term volatility expectations, and so they may be of greater use for investors with shorter timeframes. Moreover, there are many other ways to measure market volatility—with each offering unique characteristics and weaknesses. These include:
- Percentage of days of volatility: Large price moves may portend increased volatility, and a trend of an increasing number of significant daily price changes could characterize a more volatile market. For example, during January and February 2016 (when relative market volatility increased), the S&P 500 moved more than 1%, in either direction, on 22 out of 40 trading days. That’s compared with just seven out of 43 days of greater than 1% moves in either direction during March and April (when volatility lessened).6 Of course, this method looks at past performance and may not be indicative of investors’ volatility expectations for the near future.
- Standard deviation, beta, and maximum drawdown: These measures are among the most commonly used ways to assess volatility and risk over relatively longer periods of time. Much of this type of data is readily available in many trading and research platforms, including on Fidelity.com, and can be a useful tool for measuring volatility. However, there are some drawbacks. For instance, standard deviation assumes that a security or index’s returns are normally distributed and it only reflects historical volatility.
If you are considering utilizing volatility measures, it may be helpful to choose a combination that aligns with your timeframe, investing objectives, and risk constraints.
Reading the VIX and SPYIX
According to Whaley, the historical average of the VIX since its inception is about 20. Thus, investors can compare the daily level of the VIX (around 12, as of mid September) to get a sense of how nervous the market is over the short term, compared to its historical average.
Given that SPYIX does not have as long a track record, it may not yet be possible to make such a comparison to the current level. SPYIX’s current level is near 12 as well (it did spike more than 50% on September 9).7 However, you might begin monitoring SPYIX, along with a variety of other tools, to get a sense of how volatile the market is. You can then make your own judgment to see if SPYIX is a useful measure of how much fear is in the marketplace at a given point in time.
4. Source: Source: Mike Patton, Integrity Wealth Management, Think Advisor. Retrieved from http://www.thinkadvisor.com/2016/07/26/exploring-volatility-with-the-inventor-of-the-vix?slreturn=1469567811
5. NPR.org. Retrieved from http://www.npr.org/2015/08/28/435577910/a-close-look-at-the-volatility-index
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