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Volatility Divergences

21 Sep 2020 ‚óŹ 04:17 AM

The typical relationship between the Index and VIX is that is one makes a higher high the other makes a lower low. Similarly if the index is falling the VIX is rising. This is true most of the time. However, at times the two diverge from each other often at important turning points in the market. The non confirmation may signal in advcae that the current trend is near its end. 

We can first verify this for the Month of March 2020, where on 09/03 when the markets gapped down to a lower low, the VIX also made a higher high, however on 23/03, the new low in the Nasdaq was not confirmed by a new high in the VIX. This divergence signals that the market does not agree with you.

In the current context the last two days of market panic in US equities saw a new low in the Nasdaq but that new low was not confirmed by a higher high in the VIX. The VIX made a high on 04/09 when the Nasdaq first declined for 2 consecutive days. However the recent two day decline does not carry the same level of fear. The VIX reflects the volatility embeded in the price of options. If the market perceived greater risk to stocks the price of options would go up accounting for it. As of now that has not happened. The market is saying this is a fake out unless proven otherwise. The result should be a bottom in US equities near term and a bounce back in the coming week.

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