Does Friday’s Drop In Fear Matter?

The market continued to fall on Friday and the S&P 500 posted another new closing low. Several fear gauges showed less extreme readings than Thursday, though. Participants seemed to take the selloff in stride. For example, while still relatively high, the VXO, VIX, CBOE Total Put/Call and CBOE Equity Put/Call ratios all dropped.

I ran some tests to see whether the lower fear levels occurring on a day where the S&P 500 made a substantial low indicated more selling was likely to come. For my tests I used the VXO. The conditions I layed out were 1) The S&P 500 must close at a “x” day closing low. 2) The VXO must close lower than yesterday. 3) The VXO must close at least 10% above its 10-period moving average. The study seemed to indicate that extended VXO levels – even if they were less extended than the day before, had a positive impact on returns over the next week or two.

Below are the results when looking for a 20bar low in the SPX.

The fact that the VXO is stretched appears to be more significant than the fact that it pulled back.

Moving the bar out to a 100 bar low for the SPX gave these results.

In short, Friday’s slightly reduced VXO levels don’t seem to have any negative connotations.

In my post on Friday I discussed the high put/call ratios. For some other interesting perspective on these numbers, check out the links below:
Traderfeed – An interesting study and indicator to add to your p/c charts.
Daily Options Report – Some thoughtful musings on p/c related to volatility.
VIX and More – A long term view of the equity p/c ratio.