The S&P 500 is exhibiting an unusual volatility dynamic, with its 20-day historical volatility falling below 6% for the first time in over a year, while the CBOE Volatility Index (VIX) has simultaneously risen, pushing the VIX premium over historical volatility above 180%. Although individual signals for low historical volatility can be mixed for short-term S&P 500 returns, this specific confluence of low realized volatility and an elevated VIX premium has historically occurred only twice before, with both prior instances leading to positive S&P 500 performance, particularly in the short term, suggesting a potentially bullish market signal.
The 20-day historical volatility (HV) has fallen below 6% for the first time in over a year This week, I’m examining two volatility measures on the S&P 500 Index (SPX). The 20-day historical volatility (HV) has fallen below 6% for the first time in over a year, meaning the index has been especially calm over the past 20 trading days as the index continues to hit new all-time highs. The second volatility measure, the CBOE Volatility Index (VIX), reflects the expected volatility over the next 30 days based on SPX option prices. Interestingly, while realized volatility (the 20-day HV) has collapsed, expected volatility has been rising resulting in an elevated VIX when compared to the HV. Below, I look at what all this could mean for traders. Falling HV Going back to 1994 (the first full year we have daily VIX data), there have been 12 previous instances of the 20-day HV on the SPX falling below 6% for the first time in at least three months. The table below summarizes the subsequent returns for the SPX after those signals. The results are mixed, with the index doing well in the first week, averaging a return of 0.44 that beats the typical one-week return of 0.20% (see the second table below). But it seems to peak at about that time, as the average two-week return is lower (0.42%) and the one-month average return of 0.11% significantly underperforms the typical one-month return. The longer term returns show slight outperformance. The median return doesn’t show the drop off at one-month, indicating it’s only a few signals that skew the results. I wanted to look at the individual returns to see exactly what was going on with these mixed results. More specifically, I was interested the one-month timeframe. The table below shows the signal dates and returns. What jumps out to me is that in three of the last four occurrences, the SPX was down more than 5% over the next month. VIX Premium to HV As the 20-day HV of the SPX was falling to below 6%, the VIX was rising from the September low close of 14.71 to the close last Friday of 16.65, which was the day of the recent signal (the VIX is even higher now). That sent the VIX premium to HV above 180%, its highest reading since late 2021. There have been seven instances where the premium moved above 180% for the first time in at least three months. The first signal was December 31, 2010, so the second table shows anytime returns since 2011 as a benchmark. Stocks have tended to perform very well after these instances. One month after these seven signals, the SPX averaged a return of 1.9%, with six of seven returns positive. Here’s a look at the individual occurrences. I’m including the VIX close on the day of the signal. The last time was in late 2021 and this turned out to be one of the bad times to be long on stocks. The first two signals (2010 and 2012), with the VIX just below 18, were the times when the VIX was closest to the current level. Those were two very good buying opportunities in the short term. High Premium with Low VIX Finally, I found two periods in which we saw the VIX premium to HV reach 180%, while the 20-day HV of the SPX was below 6%. Those two times are shown below. Hopefully, this is a signal of what’s to come. The SPX was positive each times going forward, especially in the short term. The S&P 500 (SPX) is currently experiencing an unusual divergence in volatility metrics, with its 20-day historical volatility (HV) falling below 6% for the first time in over a year. Simultaneously, the CBOE Volatility Index (VIX) has risen from its September low of 14.71 to 16.65, pushing the VIX premium to HV above 180%, its highest reading since late 2021. This indicates a market where realized volatility is exceptionally low, yet expected volatility remains elevated. Historically, instances of the 20-day HV dropping below 6% have shown mixed short-term SPX returns. While the average one-week return of 0.44% beats the typical return, the one-month average of 0.11% significantly underperforms the typical, with three of the last four occurrences seeing SPX declines exceeding 5% over that period. However, the median return does not show this one-month drop-off, suggesting outliers skew the average. In contrast, the VIX premium exceeding 180% has historically been associated with strong SPX performance. Following seven previous signals of this magnitude, the SPX averaged a 1.9% return one month later, with six of seven instances showing positive returns, excluding a notable exception in late 2021. The two earliest signals (2010, 2012) occurred with VIX levels near current readings and were described as good short-term buying opportunities. Crucially, the current confluence of both the VIX premium above 180% and the 20-day HV below 6% has only occurred twice previously. In both prior instances, the SPX posted positive returns, particularly in the short-term, suggesting this specific combination could be interpreted as a potentially bullish signal despite the mixed individual HV-alone implications.
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