$VIX Spike Peak Buy Signals: A Trading System (VIX)

By Lawrence G. McMillan

It is well-known to our subscribers and somewhat known to the trading public in general that a spike peak in $VIX is a buy signal for stocks.  In fact, it goes farther than that – a volatility spike peak in any entity is a buy signal for that entity.  In this article, we're going to try to quantify such buy signals.  This is being done partially to construct a trading system from them, but also to gain some more understanding as to just how important these signals are.  For example, there have been eight such signals in the past year; six were profitably closed; one was closed for a loss; and the eighth is open and highly profitable right now (having bought on April 19th when $SPX closed at 1555).  Let’s begin with some examples of volatility spike peak buy signals, and then develop the trading system.

Spikes in $VIX

When the stock market sells off sharply, it is common (although not mandatory) for volatility measures to increase rapidly.  This is generally due to the fact that traders and investors panic and begin to buy (out-of-the-money) puts as protection.  They do this during the market decline, and they tend to overpay for the puts as protection, thus increasing the implied volatility of the options more and more rapidly as the market falls.  I always liken this to waiting until your house is on fire to decide to buy fire insurance.  It’s pretty expensive at that point.  Likewise, put protection is expensive when the market is already locked in a rapid decline...

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