The Rarity of a VIX Above 38: A Historical Analysis. Only happened 3.8% of the time
In recent days, the global financial market has been rocked by a series of alarming news events that have generated panic among investors. An unexpected 3% drop in the S&P 500 in a single day caught many by surprise, grabbing headlines and sparking widespread anxiety. However, what truly captured attention was the CBOE Volatility Index, known as the VIX, which surged to a level of 38. While the market drop was not unusual, the magnitude of the VIX spike was, marking a rare event that has only occurred five times in the past 30 years.
This sudden rise in the VIX took many traders off guard, particularly those who use options and leverage-heavy strategies. As a result, several of my colleagues who employ high buying power in their trades saw their accounts plummet, with losses ranging from 30%, 50%, 90%, and some even losing their entire accounts. This type of movement in the VIX underscores the importance of effective risk management and not underestimating the rarity and potential impact of an elevated VIX.
The Five Times the VIX Surpassed 38
Long-Term Capital Management Crisis (1998): During the LTCM crisis, involving a famous hedge fund management firm, the VIX peaked at 46. This was a period of significant financial uncertainty that resulted in a 26% drop in the S&P 500.
Dot-Com Bubble Burst (2001): The bursting of the dot-com bubble drove the VIX to a high of 45. This event marked the end of irrational exuberance in the tech markets, leading to substantial losses for investors.
Global Financial Crisis (2008): The 2008 financial crisis was undoubtedly one of the worst economic collapses in modern history. The VIX reached its highest level ever recorded, hitting 81, reflecting the absolute panic in the markets as the global financial system teetered on the brink of collapse.
International Debt Crisis (2011): Although the 2011 crisis, which included debt issues in Greece and other countries, was not as catastrophic as 2008, the VIX still reached a significant level of 48. This crisis highlighted the vulnerability of global markets to sovereign debt crises.
COVID-19 Pandemic (2020): In 2020, the VIX soared to 83 during the early days of the COVID-19 pandemic. This event was unique due to the global and uncertain nature of the pandemic, which paralyzed economies and markets worldwide for months.
The Importance of Understanding VIX History
Understanding the history of these VIX spikes is crucial for investors as it provides context on how markets react during extreme crises. It’s important to note that while the VIX hit 38 last week with only a 3% drop in the S&P 500, in previous events like 2008 or 2020, markets experienced much steeper declines before the VIX reached those levels.
This recent behavior of the VIX could be influenced by additional factors, such as the increase in available information, the speed at which it spreads, and the sophistication of market participants. This has caused the duration of volatility spikes to be shorter in the past 15 years, with the exception of events like the 2020 pandemic.
What Does This Mean for Investors Today?
The VIX reaching 38 is a rare and unpredictable event, occurring only a few times over several decades. Because of this rarity, it's not something traders can plan for in a typical trading strategy.
Instead, the advice is to maintain a conservative approach, such as keeping small positions and using effective risk management techniques, because the sudden spike to 38 or higher can be very disruptive. In other words, trying to anticipate or bet on such a rare occurrence can be highly risky and is not a reliable strategy for most traders.
Given that a VIX above 38 is a low-probability event (only 3.4% of the time since 1995), investors need to be cautious yet strategic. History shows that these levels can offer significant opportunities but also considerable risks. It’s essential to maintain small positions and carefully manage risk, as volatility can remain elevated for extended periods, as seen in 2020.
This recent event has highlighted the importance of not underestimating the impact of a high VIX, especially for those using options and leveraged strategies. Prudent risk management not only protects capital but also allows for the effective capitalization of opportunities that arise during periods of extreme volatility.
In summary, while these events are rare, when they do occur, they have a profound impact on the markets. Understanding the historical context of these volatility spikes can help investors better navigate times of extreme uncertainty and avoid costly mistakes.