Be like Buffett and use the VIX to buy fear and sell greed in the SPY.
The VIX finally closed below 30 and below the 20-day moving average of 31.20 on Friday. It is also approaching the critical area of 27.50 that served as serious upside resistance for most of September until it finally collapsed. The tech bubble’s gains beat Apple (AAPL) and Microsoft (MSFT) next week, and the Fed’s rate decision the following week will likely tell the story of the direction of both stocks and the VIX toward the end of the year.
I had written an article in end of August on how option prices can help predict future stock prices. I specifically used the VXN -or VIX of NASDAQ stocks- to show how the big pullback in VXN equated to a short-term top in NASDAQ stocks (QQQ), as shown below.
But rather than just mentioning tops, using an IV-based methodology can be a robust market timing tool to help discern turning points in the overall market from both a bullish and bearish perspective.
Keep in mind that the VIX and VXN are both measures of the 30-day implied volatility (IV) in the S&P 500 and NASDAQ 100, respectively. In this article, I’ll explore how using the VIX can greatly help distinguish emerging market movement. for the S&P 500 (SPY), both up and down.
The chart below shows how the extended gains in VIX towards 35, followed by subsequent weakness, have been a bona fide buy signal in SPY over the past year. By contrast, sharp declines were lower in VIX with subsequent strength solid sell signals in stocks.
The table below summarizes the initial buy signal and subsequent sell signal based on this VIX methodology.
The total P/L for the 5 buy and sell signals is 35.86%, with an average gain of just over 7%. Worst gain was still 3%. Compare that to the total loss of over 20% in the SPY over the past 12 months.
The average days for each buy/sell signal was about a month. The total time for all signals together was less than half a year. So big gains in less than 50% of the time using the VIX methodology compared to bigger losses holding SPY all the time.
A few weeks ago, a new buy signal was generated as the SPY hit annual lows. There is no clear sell signal yet, but the unrealized gain on that latest buy signal is now over 5%.
Using the VIX to help determine if the SPY is at a turning point is akin to Warren Buffett’s adage to be greedy when others are anxious and anxious when others are greedy. Sure, a bit of the fear has come off the mark when VIX is a guide. Still haven’t reached the greedy level, so stay tuned and see what happens in the coming weeks!
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All the best!
SPY shares closed at $374.29 on Friday, up $8.88 (+2.43%). Year-to-date, the SPY is down -20.28%, versus a % increase in the benchmark S&P 500 index over the same period.
About the author: Tim Biggam
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as Market Maker for First Options in Chicago. He appears regularly on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network “Morning Trade Live”. His overriding passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of the POWR options newsletter. Read more about Tim’s background, along with links to his most recent articles.