VIX Doesn’t Work as Signal for Stocks, Birinyi Says

March 17 (Bloomberg) -- Investors looking for clues about the U.S. stock market should probably ignore the Chicago Board Options Exchange Volatility Index, according to a study of the VIX by Birinyi Associates Inc.

Speculation that equity returns will be positive after the volatility gauge decreases and negative when it climbs has little basis in fact, Birinyi said. The VIX provides a summary of historical price swings and tends to move in lockstep with equities instead of forecasting their direction, the firm found.

“The VIX is alleged to be an indicative indicator and has become a staple of analysts and journalists alike,” Laszlo Birinyi and analyst Kevin Pleines wrote in a report to clients yesterday. “We respectfully disagree and ultimately conclude it is a measure of current volatility with little or no predictive or indicative value regarding the course of the market.”

The Standard & Poor’s 500 Index gained an average 0.1 percent in the month after the VIX slipped 20 percent below its 50-day mean on 12 occasions since 2003, according to data compiled by Birinyi. Stocks were 0.5 percent lower after two months and 3.3 percent higher after three, the data showed. When the VIX climbed above its 50-day average on 18 occasions, equities increased after one, two and three months, then dropped after six, the study found.

Coincidental Indicator

“The VIX is a coincidental indicator,” Birinyi wrote. “It details, perhaps better than other measures, the volatility of the market today but not tomorrow or the day after.”

Traders use the VIX as a gauge of investor fear because it’s derived from the cost of options that insure against losses in the S&P 500. The research by Birinyi Associates in Westport, Connecticut, shows the VIX may work as a contrarian indicator, signaling investors should buy shares when it rises, though the correlation breaks down after three months.

The VIX fell 18 percent this year to 17.69 through yesterday, and slipped 6.2 percent to 16.59 as of 9:48 a.m. in New York today, the lowest level since May 2008. That’s below the average reading of 20.3 during the measure’s two-decade history. Options are derivatives that give the right to buy or sell assets at a set price by a specific date.

The S&P 500 has increased 4.4 percent in 2010 and is up 72 percent since declining to a 12-year low on March 9, 2009. The VIX has retreated 64 percent during the rally, according to data compiled by Bloomberg.

Volatility Formula

The index is supposed to gauge investor expectations for market swings over the next 30 days using a formula that incorporates implied volatility, a key measure of options prices, for S&P 500 Index puts and calls that are one or two months from expiration. Puts give owners the right to sell an underlying security, and calls convey the right to buy.

“I wouldn’t use it as a prospective forward-looking tool simply because the market is inherently unpredictable,” said John Carey, a Boston-based money manager at Pioneer Investment Management, which oversees more than $200 billion. “I look at the VIX and some of those other charts from time to time. It’s certainly one of a number of measures of market mentality and market emotion.”

Birinyi, a research and money-management firm that oversees about $300 million, analyzed the VIX’s performance since September 2003, including six periods of “extreme” volatility. The following is a table of the S&P 500’s average gain or loss during periods after implied volatility climbed above or fell below the 50-day average:

                 1 Month    2 Months    3 Months    6 MonthsVIX 20% Below     0.09%      -0.49%       3.33%       5.84%VIX 20% Above     1.25%       0.50%       0.95%      -4.51%Source: Birinyi Associates