Introducing the VIX Mix

The VIX Mix is a composite of more than a dozen indicators that assess the condition of US equity markets through the lens of volatility. Some do this through direct observation (VIX relative to its historical range) while others measure component relationships (e.g. VIX versus VIX3M) and some monitor price trends.

The composite score runs from zero (most bearish) to 100 (most bullish) with a neutral zone between 35 and 65. The trick to a gauge like this is to identify the tipping points where sentiment has shifted from bearish toward bullish or vice versa. The component indicators can also help investors stick with a direction when there may be crosscurrents. We’ll do our best to tease out underlying signs that point in one direction or the other.

Here's the current list with brief descriptions. Deep dives will follow. The order doesn’t matter as they all have equal weight in the composite. We reserve the right to add or subtract from this list though we don’t expect much to change. And, yes, we are aware that some indicators share underlying components, but we believe our construction of each one results in added perspective.

- VIX Rank: Quite simply, where the current value ranks relative to historical values going back to 1993. For purposes of the composite, we invert the rank so that low VIX values come through as bullish and high values are bearish.

- VIX Z-Score: Credit to Dr. Ken Long of Tortoise Capital (www.tortoisecapital.net) for pointing me to this one many moons ago. Take a ratio of two moving averages on VIX relative to its history (Z-score) to see when conditions are stretched too far and may reverse course.

- VVIX Rank: As above, where the current “volatility of volatility” ranks relative to its history with rank inverted (low is good and high is bad).

- VIX-VOLI: Everyone knows that VIX measures 30-day implied volatility using a broad range of S&P 500 option prices. Fewer people are familiar with Nations VolDex Index (VOLI from www.nations.com) that uses only at-the-money options to more narrowly define volatility. The short version is that a large spread between VIX and VOLI activates our Spidey sense.

- VIX Squeeze: When equity markets are happy, VIX will sometimes move in an increasingly narrow range. These quiet periods are measurable and present the potential for an eruption of volatility. Our methodology for measuring squeeze conditions shares some of the approach used by Andrew Thrasher in his award-winning paper, “Forecasting a Volatility Tsunami” (www.athrasher.com)

- CBOE volatility term structure: We use five constant-maturity measures of implied volatility to assess risk premiums. These are VIX9D, VIX, VIX3M, VIX6M and VIX1Y. A steep term structure tends to pair with bullish equity markets. Flattening or inversion are less friendly.

- VIX and VIX3M: Isolating this relationship between 30-day and 3-month implied volatility shows signal value looking at changes in the trend of the ratio. A rising ratio is a cautionary sign for equities and vice versa.

- VIX3M and VIX6M: Another snapshot from the CBOE term structure that has demonstrated signal value.

- Ratio Combo: An aggregate look at the relationship of VIX, VIX3M and VIX6M. Duplicative? Somewhat. We’re OK with that.

- VIX Futures Term Structure: Where the CBOE volatility term structure is derived from S&P 500 option values, VIX futures are traded contracts that have their own term structure. We look at the relationship of the front month to the second month and the second month to the third month.

- VX30 to VIX: In normal times, we expect VIX futures to trade at a premium to “spot” VIX. But the VIX futures contracts have an expiration cycle that makes comparison tricky. Our solution is to calculate a “constant maturity” futures value using the first two months – what we refer to as VX30. Happy investors cause VX30 to trade at a healthy premium to VIX. Angry investors push VIX above VX30.

- Mid-Term VIX Futures/Short-Term VIX Futures: Another take on the volatility term structure is to look at the relationship between the S&P 500 VIX Short-Term Futures Index (a blend of the first two months of VIX futures tracked by the ETF “VIXY”) and the S&P 500 VIX Mid-Term Futures Index (a blend of the fourth, fifth, six and seventh month VIX futures tracked by the ETF “VIXM”). VIXY tends to rise and fall faster than VIXM and changes in direction can be informative.

- Short-Term VIX Futures Trend Trade: Our view is that long volatility positions should be viewed as swing trades (typically defined as a few days to several weeks) with defined entries and exits. Our method looks at two moving average crossovers and quantifies the spreads to give us a number for the composite.

- Trading The Fear Index (TTFI): Technical analyst Markos Katsanos (www.mkatsanos.com) published a research paper detailing a methodology that identifies trend changes using the S&P 500 and VIX. We’ve tweaked his approach and included it as a component here.

- S&P 500 overbought/oversold + VIX: Rob Hanna of Quantifiable Edges (www.quantifiableedges.com) won an award for his research on SPX (S&P 500) and VIX. As with TTFI, we tweaked his methodology to add another arrow to the quiver.

- Ratio of SPY to VIX: This one gets purists fired up because SPY trends higher and VIX has mean reverting characteristics such that the ratio will trend higher over time. We agree but find that turning points in the ratio have signal value in identifying market reversals.

- Our “OG” VolStrat: Going all the way back to 2015, we developed a simple set of rules using CBOE vol indices. It provided great signals for shorting vol (long XIV back in the day) but was too slow to take the long side. It remains valuable as a weathervane and fills out our VIX Mix components.