My colleague at Expiring Monthly, Adam Warner, has taken people to task over the last several days for obsessing over the VIX, and especially for misapplying it:
OK, what’s wrong with this statement:
Look at that…$VIX drops below 20 and pigs fly again. Only reliable indicator that I know of that level.
If you answered “everything” you would be correct. But let’s see how far off the reservation someone can go in 140 characters. And again, this is a very sharp mind, albeit from other areas.
Problem 1 is, there’s no magical round number level in the VIX that has any meaning over another level. The move from 21 to 20 for example has no greater meaning than the move from 20 to 19 (no points for commenting that the percentage move is greater from 20 to 19). VIX at 20.10 does not imply a wild market, while 19.90 means all’s calm, buy everything.
Problem #2 is, the whole concept is utterly backwards. Umbrellas don’t cause rain. Lower VIX does not cause a calmer market, rather it’s a reflection of a calmer market.
Now, Adam’s a true gentleman, and doesn’t call out the offending Twitter denizen here by name. But I saw that particular tweet go by, and have seen similar comments from that person – and many others – in recent months. There are two misconceptions at work in much VIX commentary. First, people don’t understand that correlation is not causation. Any sentence composed of the semantic atoms “the market” and “VIX” and the connective “because” is fraught with logical danger; a safer alternative will always be to simply note that “the market [rose/fell] and the VIX [rose/fell],” removing the implication of causality entirely. The second problem is that people don’t understand what the spot VIX is. Phrases like “the fear index” are just metaphors. The spot or cash VIX level is not entirely meaningless, but it’s no more meaningful than any other local metric of implied volatility.
In fact, I can’t think of a single trader for whom the spot VIX is absolutely essential. For any optionable asset, whether a stock, ETF, commodity, or index, the implied volatility of the individual options being traded are easily calculated, and are far more important than the VIX snapshot. I frequently trade VIX futures, but even in that case I don’t regard the spot VIX as a crucial piece of information, since I’m primarily interested in the term structure of the futures, not the blips in the 30-day spot statistic. I think the reason the spot VIX has because so popular is that we’re all a bit lazy sometimes, and will tend to opt for the simplest, most accessible broad barometer available. The commentariat could easily replace VIX with SPX at-the-money implied volatility and lose nothing in translation.
Adam is ready, in a tongue-in-cheek way, to ban the spot VIX. I concur. If someone wants to comment about goings-on in the VIX products (which have their own conceptual barriers to entry) in an intelligent way, I’m happy to listen. But using the VIX for general market commentary is like revving up your SUV just to walk the dog.