Interesting article on Bloomberg regarding the future direction of VIX, and its reaction to tomorrow’s employment report. In the article, MKM Partners expects VIX to drop below 20.
The article doesn’t say whether the options strategist at MKM expects VIX to drop below 20 tomorrow. More important, what the article did do was give me an opening to discuss one of the analytical tools that we developed here at FMR — the ODDS Volatility Map!
What this “map” does is graph the percent change in the S&P 500 compared to the percentage point change in VXO. [I chose VXO instead of VIX to get the additional history that VXO has. Plus I like the thought of isolating this to just the at-the-money options instead of the broad spectrum of strikes.]
The beauty of the map is that you can isolate it by month of the year, by day of the month and/or by day of the week. In this particular sample, I isolated it to the first Friday in September — the day the government comes out with the payroll data.
Let’s take a look at one of the data points to make sure you understand what it means. In the lower right corner is a data point with an x value of about 3% and a y value of about -4%. That’s from the first Friday in September 1999, when the S&P 500 was up 2.99% and the VXO fell from 25.44 to 21.39, a drop of -4.05 percentage point.
Do that for each of the first Fridays in September since 1986 and you get the data points. Do a linear regression, and you get the trendline. That trendline provides an idea of what kind of move in the stock market it would take in order for the VIX to drop below 20 tomorrow. Basically, 75% of the move in index implied volatility on the first Friday in September is determined by the action in the S&P 500. Also, if the stock market does nothing tomorrow, the index is likely to drop about -0.46.
Of course it’s not perfect. The trendline doesn’t perfectly tell us what will happen. But it does provide a pretty interesting map of what to expect with VIX and VXO given certain market reactions.
What’s interesting to note is that on all other Fridays in September, you don’t have that negative y-intercept. That is, for all Fridays that are not the first Friday in September, you tend to not have that volatility fade going into the weekend. But you can also see that the correlations tend to break down, falling from 75% to just 47%.
– Don
Brilliant piece!
Good insight, as usual.
Just for the record, payroll is not always the first Friday (44 months since 1980 it was released on the 2nd Friday, and 1 month on the 3rd Friday, per St. Louis Fed’s vintage release Alfred database). But you are correct here, as none of the 45 months were in September.
Thanks for sharing your good work and analysis.