SentimenTrader ---- The VIX Index meets the month of October

 

The VIX Index meets the month of October

Key points

• October has a reputation as being a volatile month for stocks and a time of supposed danger
• Actually, despite seeing several significant market declines (1929, 1978, 1979, 1987, 1997, 2008), overall, October has been a favorable month for stocks
• Nevertheless, presidential election year history suggests being prepared for a spike in volatility - and whatever might accompany it - during October 2024

The VIX Index

The VIX Index measures the implied volatility (i.e., estimated future volatility) of near-term at-the-money SPX (S&P 500) index options. If the SPX moves significantly, new strike prices are used to calculate the VIX. Since there is a skew to options prices and implied volatility changes with the strikes, the VIX will typically rise when the market drops and fall when the market rises. This is not always the case, but the correlation is clear.

The standard interpretation of VIX movements is that the VIX will rise when fear or uncertainty does since there will be a greater demand for put options. Conversely, traders typically become complacent when the market rises, and the VIX will fall as the demand for put options decreases.

While the range within which the VIX tends to travel can change over time, when it drops below 12%, it can show excessive optimism, and when it is above 30%, it shows excessive pessimism.

The VIX Index meets the month of October

So, how does volatility behave during the month of October? Well, it's volatile. The chart below shows the hypothetical fluctuations of the VIX Index (using $1.00 as a baseline starting point) during the month of October since 1986.

See a pattern? Me neither.

Now, let's consider presidential election years versus all others. The chart below shows the hypothetical fluctuations of the VIX Index (using $1.00 as a baseline starting point) during the month of October since 1986, excluding presidential election years (.i.e., 1988, 1992, 1996, etc., are excluded).

This chart appears to have a much more unfavorable bias. Now, let's look at October VIX performance only during presidential election years.

The chart below shows the hypothetical fluctuations of the VIX Index (using $1.00 as a baseline starting point) during the month of October since 1986, only during presidential election years (i.e., only 1988, 1992, 1996, etc. are considered).

Notice anything different about this chart?

The table below summarizes the VIX Index performance during October of presidential election years.

What the research tells us…

So is the implication that volatility is going to soar during October 2024 - and, by extension, that the stock market is likely to pull back since sharp spikes in volatility and market declines tend to go hand-in-hand? Not necessarily. In fact, there is absolutely no guarantee that the VIX Index will rise during the month ahead. Still, when we combine the historical tendency for higher volatility during October of election years with the fact that it has gotten awfully easy to make money in the stock market lately, a pullback in the market would not come as a surprise.