Sunday, May 17, 2009

Vix Asset Allocation Model Explained Simply With as Few Words as Possible

Added 12/12/11: One of the most recent, detailed discussions of this topic can be found in a October 2011 Post:  Mark Hulbert and the Use of the VIX as a Timing Model/Modification # 1 To Vix Asset Model Approved re: Hedging
Assessment as of August 2015 Unstable Vix Pattern: A Trigger Event In The Vix Asset Allocation Model 8/31/15 - South Gent | Seeking Alpha

Assessment as of  July 2016: Stable Vix Pattern/ Possible reasons discussed at Update For Portfolio Positioning And Management As Of 7/24/16 - South Gent | Seeking Alpha

Added 10/17/14: I copied in a recent Seeking Alpha article the volatility readings from the 3 prior Trigger Events which shows what is required to classify a VIX spike as a Trigger Event under my VIX Asset Allocation. I received a request whether or not the spike in the VIX through 10/16/14 was a Trigger Event and the answer is no. The volatility spike must stay elevated in the high 20s for several days to qualify as a Trigger Event. One or two elevated readings in the 25-26 range are worrisome but are insufficient by themselves to cause a termination of a Stable Vix Pattern consisting of a long term movement of the VIX below 20.

August 2007 Trigger Event (multiple confirmations November 2007; January 2008; March 2008)
Aug 21, 2007 25.25
Aug 20, 2007 26.33
Aug 17, 2007 29.99
Aug 16, 2007 30.83
Aug 15, 2007 30.67
Aug 14, 2007 27.68
Aug 13, 2007 26.57
Aug 10, 2007 28.04 
Aug 9, 2007 24.46

1987 Trigger Event (based on volatility for S & P 100-VXO-VIX Data Starts in 1990)  

May 4 27.18
May 1 28.22
Ap 30 28.45
Ap 29 29.22
Ap 28 31.2
Ap 27 31.46
Ap 23 29.13
Ap 22 27.95
Ap 21 27.22
Ap 20 27.18
Ap 16 27.48
Ap 15 27.59
Ap 14 28.97

October 1997 Trigger Event (not resolved until later part of 2003, confirmed in October 1998)

Dec 30, 1997 24.38
Dec 29, 1997 26.79
Dec 26, 1997 29.27
Dec 24, 1997 30.27
Dec 23, 1997 29.86
Dec 22, 1997 28.56
Dec 19, 1997 29.18
Dec 18, 1997 27.19
Dec 17, 1997 26.33
Dec 16, 1997 26.11
Dec 15, 1997 27.37
Dec 12, 1997 27.92
Dec 11, 1997 27.63
Dec 10, 1997 24.55
Dec 9, 1997 23.36
Dec 8, 1997 23.22
Dec 5, 1997 22.65
Dec 4, 1997 23.84
Dec 3, 1997 23.92
Dec 2, 1997 25.66
Dec 1, 1997 26.01
Nov 28, 1997 27.43
Nov 26, 1997 28.95
Nov 25, 1997 28.95
Nov 24, 1997 29.80
Nov 21, 1997 26.65
Nov 20, 1997 27.32
Nov 19, 1997 29.93
Nov 18, 1997 31.58
Nov 14, 1997 33.66
Nov 13, 1997 36.64
Nov 12, 1997 37.84
Nov 11, 1997 36.38
Nov 10, 1997 36.63
Nov 7, 1997 36.27
Nov 6, 1997 32.57
Nov 5, 1997 32.18
Nov 4, 1997 32.24
Nov 3, 1997 32.09
Oct 31, 1997 35.09
Oct 30, 1997 38.20
Oct 29, 1997 33.75
Oct 28, 1997 31.22
Oct 27, 1997 31.12
Oct 24, 1997 23.17


Added 10/20/14:

I am publishing several posts at SeekingAlpha on this topic:

Trading Strategy Vix Asset Allocation Model Part 2: Hedging In An Unstable Vix Pattern - southgent1951 | Seeking Alpha

Trading Strategy Under The Vix Asset Allocation Model: Part 1 - southgent1951 | Seeking Alpha

Vix Asset Allocation Model - southgent1951 | Seeking Alpha


I received an email saying that if the VIX Asset Allocation Model is simple, then explain it in as few words as possible in one post. That is very hard for me to do, and it is late. But here goes:

There are two Main Patterns:

1. Stable Vix Pattern: Continuous Movement in the Vix below 20, an investable bull market in stocks.

2. Unstable Vix Pattern: A Whipsaw Pattern Movement in the VIX at levels above 20, a far more riskier market for the individual investor, most likely what most people would call a bear market, or a Transition Phase from a bull to a bear market.

Each Main Pattern is divided into Two Phases:

Phase 1 STABLE VIX PATTERN: Mostly moving in a range from 15 to 20
Phase 2 STABLE VIX PATTERN: Mostly moving in a range of 10 to 15

Phase 1 Unstable Vix Pattern: Whipsaw Movement in the VIX mostly in the 20 to 30 range with temporary movements below 20 and above 30, mostly descriptive of an ongoing bear market with periodic rallies, and also descriptive of a Transition Phase from Bull to Bear.

Phase 2 Unstable Vix Pattern: Catastrophic Bear Market marked by a decisive break in a Phase 1 movement by a major burst into the 40s followed by even more elevated levels in the VIX.

Alert: An "Alert" happens when either an unusual break in a pre-existing pattern occurs, or there is some meandering by the VIX above a level considered to be significant under the model, without a decisive break into a bull or bear pattern characteristic of the Transition Phase or an unstable VIX pattern. An example of an alert is the decisive break in the Phase 2 bull market pattern in the VIX in 2/07. The break was not a trigger event since the pattern broken was a stable bull market pattern Phase 2, and the Phase 1 pattern was still stable. An alert, however, should cause an investor to learn everything possible about the external events causing the alerts and to be considering possible major changes in asset allocation.

Trigger: A "Trigger" is a decisive break in the stable bull market pattern by a spike in volatility clearly outside the range tolerable for a Stable VIX pattern. Those spikes happened in two stages in 2007, in August and November. The trigger event requires a change in exposure to stocks. Timing of that change can vary, but LB has noted under all models covering the entire time period for which there is a volatility index that there would have been at least one, usually two, counter-moves back to below 20 that would be accompanied by a rise in the market average. This would afford an opportunity to lighten up at better prices than prevalent during the TRIGGER EVENT Phase. While this opportunity has happened in the past, there is certainly no guarantee that it will happen after the next Trigger Event or any other ones in the future.

Trigger Events:
April 1987 based on volatility index for the S & P 100 (VIX data starts in 1990): Parallels to VXO 1987-1988
October 1997:  More on VIX AND ASSET ALLOCATION
August 2007: VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern

Green Light: During an Unstable VIX Pattern, the VIX will periodically move below 20.  A Stable VIX Pattern is not formed until there is continuous movement in the VIX below 20 for 3 months. Some minor movement above 20 is allowed without restarting the count. 

Green Light Signals:
May 1991 and Terminated by Trigger Event October 1997: VIX and S & P Compared 1990 to 1997
January 2004 and Terminated by Trigger Event August 2007: More on VIX AND ASSET ALLOCATION
September 2012- Stable Vix Pattern as of 9/26/12

Non-Confirmation Event: The rise in the market is not being confirmed by the movement in the vix. The most important series of non-confirmation events occurred in 1999, when the VIX meandered at levels inconsistent with a rally in stocks. The model would require selling into non-confirmation events. 

TRANSITION PHASE: The formation of an Unstable VIX Pattern out of a Stable VIX Pattern, marked by a Whipsaw Pattern of up to 30 or so on the VIX, followed by a movement down below or near 20, while pundits still view the bull market as ongoing. An example of a Transition Phase would be the start of the Unstable VIX Pattern in August 2007 even though the Bear Market is dated as starting in October 2007. This is sometimes called the Warning Phase.

The basic premise is that increased volatility means increased risk. With increased risk, there comes a significant danger of lower stock prices as a means for the market to compensate and adjust for that increased risk. The Model is basically saying the STABLE VIX Pattern is a bull market, and the Unstable VIX Pattern is a bear market or at a minimum a far more riskier market for the individual investor, particularly one facing situational risk. The Model does not tell an individual what to do or how much to sell after a Trigger Event. That is up to each individual based on their tolerance for risk, ability to manage it, and most importantly their unique situational risks.

The Model has in my opinion been successful in predicting bear markets and the start of bull markets.

During an Unstable Vix Pattern, a buy and hold strategy for stocks is abandoned in favor of a hyper active trading strategy. A constant allocation shift is performed, raising and lowering stock allocation. It is anticipated that the S & P 500 will show no gain after inflation, even with reinvestment of dividends, during the Unstable Vix Period. VIX-Formation of Phase 2, Unstable Vix Pattern (discussing Unstable Period from October 1997 to March 2004).

Anyone serious about learning about this model needs to read and digest all of the posts on it.

Some of the more important Posts are these: