The Calm before a VIX Pop: Options and Volatility Strategies

The Calm before a VIX Pop: Options and Volatility Strategies


  • Markets are near highs and volatility is near lows, historical data shows that a low VIX can be taken advantage of for short term trades.
  • Seasonality of VIX closing prices vs. mean and median levels since 1990.
  • Macro reasons to consider trading protection.

Volatility is near multi-year lows as the major indices have been trading just under all-time highs. In February, the Dow Jones Industrial Average crossed above 20,000, the S&P 500 traded above 2,300 and the VIX temporarily broke below 10.

This is all occurring at the same time macroeconomic uncertainty is quantifiably at an all-time high, the Fed and other global central banks are unwinding the biggest monetary intervention ever, waves of populism are electing new political administrations, and aggressive stock valuations are the norm.

For context, the below charts quantify and depict a number of the above topics. Starting off with equity returns and current volatility levels.

Low Implied Volatility

The SPY (SPDR S&P 500 ETF Trust) is up 60% cumulatively over the last 10 years. As such, volatility derived from its options is near all-time lows. Other major products like the Russell 2000, Dow Jones Industrial Average, and NASDAQ 100 (as measured by the IWM, DIA and QQQ respectively) are also at relative lows implied volatility wise. Depicted below from Interactive Brokers (IB). (

The VIX (Implied Volatility on S&P 500 30-Day Options) is another measure of volatility and complacency. As depicted below from IB, the CBOE’s VIX is hovering at 10-year lows. But what happens when the market inevitability has a hiccup? In the next chart, we explore what happens to the volatility of options on the SPY.

Across the term structure (each option’s expiration and corresponding volatility level) investors will note that options premiums spike on days where equities have a downdraft. The relative price of options, or implied volatility, shifts in a large way.

The example below is from June 24, 2016, a day when the S&P 500 dropped 3.5% after the Brexit vote to leave the EU. The day prior, the VIX closed at $17.25. Following the news, volatility shot up to $25.76 (a 49.3% pop in implied volatility (IV)). Near term options tacked on 7 volatility points, while the rest of the curve shifted up. Today’s SPY IV levels are included for context.

The market has also been trading within its implied ranges. From a historical volatility point of view, the implied move has been above the realized move for all the major US indices.

Volatility Trades

The mean reverting nature of volatility can be taken advantage of. The below is a brief study on historical VIX moves from January 1990 to December 2016. 2017 data was excluded to avoid including an incomplete year and therefore skewing the seasonality data.

According to the data compiled, the average VIX level is around $19.64. An alternative method, the median, puts the VIX midpoint frequency at $17.77. The median and mean both have their mathematical pros and cons, but the point is that we now have some context as to normal VIX levels. With these stats in mind, volatility is currently extremely low. While this is most likely due to globally accommodative central banks and near zero interest rates, albeit rising interest rates, this level of volatility is rare. During the period of interest, only 4.75% of the time the VIX closed below $11.50. To that point, seasonally speaking, the December, January and February months had the highest chances of closing below $11.50. Other figures tested include the number of closes below mean and median levels. Another key takeaway, was that 49.96% of the time the VIX was closing below its median level and 59.55% of the time below its average level. The chart below outlines the aforementioned VIX monthly statistics, courtesy of data from Yahoo.  (

Contrasting these prices with today’s prices presents an opportunity, historically speaking. The following graphic displays VIX returns after X trading days held. X ranged from 1-10 days. The trade was initiated on a day where the VIX closed below $11.50. From a risk / reward ratio point of view, the 10-day hold period was the most optimal. On that trade, the best return was a 95% pop in the VIX and the worst being a 11.03% drop in volatility, or an 8.7 reward to risk ratio. The max gain during this period included the VIX pop from 2/16/07 to 3/5/07. The trade logic was long volatility on a day New Century Financial plunged nearly 70% after a Justice Department probe announcement and news that KPMG said they thought “there was substantial doubt about New Century’s ability to function as a going concern,” as CNN wrote in a piece at the time. The SPX dropped from $1449.37 to $1399.04 on that day over cracks in the subprime market. ( The table below elaborates on the various returns from this strategy.

There are some important notes on the above graphic however. The VIX index was used, as such one can construct trades using VIX futures, VIX index options, or volatility related ETFs (like the VXX, UVXY, etc.)…as one can not trade the VIX index directly. From an optimization point of view, the trigger price for a trade ($11.50 in this case), days held, and product-type are all avenues for further research.

The mean reverting nature of volatility seems to be a consistent theme and the odds favor slightly higher implied volatility going forward. In addition to the supporting stats, there are also some fundamental reasons to consider trading protection.

Other reasons to consider protection 

From an economics point of view, the world is rather risky now. The Economic Policy Uncertainty Index, who is supported by the Sloan Foundation for their economic research, is at an all-time high. The index looks at newspaper coverage of policy-related economic uncertainty numerically, components of tax codes set to expire, and disagreement among economic forecasters. The global index also includes 18 different countries in its logic. The Global Economic Policy Uncertainty Index with PPP-adjusted GDP Weights is displayed below and has been trending upward for a while. (

Parts of this uncertainty trend is being driven by waves of populism, electing new political administrations around the world. Building up borders, less aggressive international trade, and other protectionist undertones are certainly adding to economic tensions. The evening Trump took office and the day the UK left the EU are recent examples of politics influencing the economics of the market.

Outside the political arena, stocks are quite expensive.

According to data from FactSet, the 20-year average S&P 500 forward P/E ratio is 17.2. For additional insight, the firm also notes a five-year, ten-year, and fifteen-year forward P/E of 15.2, 14.4 and 15.2 respectively. Current estimates put the S&P 500’s forward P/E at 17.6 and 18.2 according to FactSet and Birinyi Associates sources. On a few levels, the market is slightly rich.

Another data point to consider is the Cyclically Adjusted P/E Ratio (CAPE). This figure is a price-to-earnings ratio derived from average inflation-adjusted earnings for the last ten years. The market currently rests at 28.93, with an average of 16.7 and median of 16.1. We stand at price levels so lofty, 96.1% of all occurrences since 1881 are below today’s CAPE according to Zero Hedge. The tech bubble and roaring 20’s were the observations that had levels above current figures. While this does not mean equities can’t remain expensive, investors should understand the level at which prices are currently for additional context. (,,,


Volatility is not a long-term investment. Operations in the volatility market should be well timed to capture the fear of the masses, as it will most likely return back to the mean thereafter. Well-timed volatility trades can reap incredible returns when there is a macroeconomic event or sell-off in the equity market. However, understanding that volatility is more of a trade than an investment is a key takeaway. Protection will melt away as time goes on, especially at-the-money options.

Time decay of long options will eat away at profits and the principal investment and only faster as time marches toward expiration. Optimizing trade location (timing of entering in the trade) is a material variable. $11.50 was used in this article because that seemed to be a technically important support level and the early stats seemed to support that thesis. However, there are many ways to further optimize the trade.

Given the current backdrop of high equity valuations and economic uncertainty, low volatility levels are a trading opportunity. Mean reversion strategies from statistically infrequent low VIX readings have proven to be a decent risk-reward.


Elite Wealth Management Team

Full Disclosures:
This article is not intended as investment advice. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities.  For a complete list of recommendations made within at least the past year, please contact us at (425) 828-4300 or  Please Note: it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.

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