One of Ronald Reagan’s favorite sayings was doveryai, no proveryai which loosely translated to “Trust, but Verify”. Probably no one in the option business is more trustworthy than Larry McMillan and we trust all he says, but we wanted to verify something as well. According to our recollection Larry has consistently stated that when the VIX spikes up and is followed by two down days, this may be considered a short term buy signal for the overall stock market. At the Options Institute we took this theory and tested it a bit.
We have VIX data going back to 1990 and S&P 500 closing prices going back that far are readily available through Yahoo finance. Using that data we ran the following test –
- The VIX closes up 5% from the previous day
- Within 5 days after this “spike’ the VIX is down two days in a row.
- Buy the S&P 500 and hold for 20 days.
Going all the way back to January 1, 1990 through August 31, 2011 there have been 58 instances of the VIX index moving up 5% and then being followed by a drop in the VIX two days in a row within the next 5 days. 42 of those 58 instances results in a gain in the S&P 500 over the next 20 days. This results in a gain of 511.73 points and a winning percentage of 72.4%. The S&P is about 900 points higher since 1990 so this is not that impressive of a gain on an index point basis.
Even more impressive, were the results from January 1, 2000 through August 31, 2011. There have been 37 signals since the year 2000 with 26 resulting in a gain over the next 20 days in the S&P 500 index. Through this method the S&P 500 has gained 227.50 points and there has been a winning percent of just over 70%. Keeping in mind that the S&P 500 has declined over 230 points over the same time period makes these positive results a little more impressive.
So if Ronald Reagan were alive today and trading the markets he would have trust in Larry McMillan’s analysis of the markets. However, being Reagan he would also want to verify what he is told. Upon verfication he might acknowledge that Larry is on to something here.
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