3-month VIX vs. the VIX

We got a question from Francis on the 3-month VIX relative to the VIX.

The CBOE 3-month Volatility Index (VIX3M) measures the expected volatility of the S&P 500 over the next three months, while the CBOE Volatility Index (VIX) measures expected volatility over the next month.

The VIX3M is usually higher than the VIX because long-term options tend to price in more uncertainty than near-term options. The ratio of VIX3M to VIX provides a measure of the volatility term structure and is used as a volatility risk premium gauge. In other words, the VIX3M vs. VIX acts as a tactical market sentiment indicator.

• When the ratio is greater than 1.0: A normal upward slopping term structure. A risk-on, calm market backdrop. Bullish market sentiment.

• When the ratio is less than 1.0: An inverted term structure. Near-term fear dominates. Risk-off and a sign of market stress. Bearish market sentiment.

• Fear is a bigger motivator than complacency.

  • Moves below 1.0 are usually panic spikes with lows sometimes well below 1.0 that either coincide or precede lows in the S&P 500. See the white areas of the chart below.

  • Moves above 1.0 and north of 1.2 suggest complacency, but the S&P 500 often continues to grind higher. The indicator usually peaks ahead of the S&P 500, forming a bearish divergence. See the light green areas in the chart below.

A tactical risk heading into September: A mid to late August bearish divergence between the VIX3M/VIX (lower highs) and the S&P 500 (higher highs) is a tactical market risk heading into the seasonality weak month of September.