Overextended VIX…. Or Is it?

One of my favorite things to chart is the Volatility Index (VIX). It’s a fickle index and that may be one of the reasons I enjoy watching it. I’ve previous discussed interesting setups taken place in the VIX (here and here most recently) and I think it’s time to address the Volatility Index once again.

This morning the VIX is up almost 17%, likely due to the lackluster earnings season we’ve been having so far in Q3 and the rumors that Bernanke won’t continue as Fed Chair if Obama is elected. The one key thing to remember when it comes to the VIX is the ability for it go continue its trajectory for much longer than many expect. But that doesn’t mean it doesn’t present itself with some mean reversion opportunities for us to look at.

Below is a chart of the VIX with a Bollinger Band overlay and the Williams %R indicator in the bottom panel. I like to use these two to help gauge where the VIX is and how far the rubber band has been extended, so to speak. Today’s price action has taken the VIX to its largest gap above its upper Bollinger Band since April. These types of pops often lose their steam fairly quickly or form a type of consolidation before either having one last burst or dropping back down.

Turning our attention to the Williams %R indicator, which is a momentum indicator that looks at the current price in relation to its highest high over the look back period, which is 35 days in the chart below. When the indicator gets above -10, we typically see some type of correction in the near future for the VIX. The indicator can be looked at on an absolute basis or for divergence from price, currently the indicator appears to be fairly stretched.

So will volatility drop like a rock? Like I said, the moves that the VIX takes can often outlast what many expect and just because it’s currently overextended doesn’t mean it can’t be more overextended (just look May ’10 and August ’11). The way earnings season is shaping up, anything is possible.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+.

About Andrew Thrasher, CMT

Andrew Thrasher, CMT is a Portfolio Manager for an asset management firm in Central Indiana. He specializes and writes about technical analysis as well as macro economic developments.