VIX and buy signals

Here’s Victor Haghani:

A high VIX1 is widely considered to be one of the cleaner buy signals out there. A recent piece in The Financial Times made the case directly: when the VIX climbs above 30, forward returns have been well above average, positive most of the time, with double-digit six-month gains.

The Financial Times case is “buy the f’n dip” logic with a VIX gate. It’s exactly the type of thing that a layreader numbly nods at when the SPX is sitting near an all-time high. The Financial Times’ case is lazy from the perspective of both investors and active traders. For the investor, it’s just survivorship bias. Knowing what we know now every pullback has just presented a bargain. The market literally “going on sale” like it’s Prime day. VIX spikes over 30 just coincide with the sales.

The question you care about is one that an active trader hearing that statement would think to hypothesis test. Given that buying any time before an all-time-high has been worked out well, how do I distinguish between relatively better or worse buys?

Back to Victor:

What that leaves out is risk. Buying the spike means taking on a lot more of it, and the strategies that did the opposite, trimming exposure when fear ran high, held up better. So the popular signal may have it backwards.

Raw returns aren’t the right thing to optimize. You care about compounded returns since investing is a repeated game. Compounded returns are risk-adjusted returns because a geometric growth process penalizes volatility.

Elm Wealth tests FT’s claim not on raw return but Sharpe Ratio, or how much return you’re getting per unit of risk taken, as the variable to maximize if we care about risk-adjusted returns.

When Fear Spikes, Should You Buy? Elm Wealth | 5 min read

What they found when they ran the numbers on S&P 500 and VIX data from 1990–2026, they found:

• A plain static stock/T-bill portfolio: Sharpe ratio of 0.50
• A strategy that buys more when VIX > 30% (the popular advice): 0.47 which is slightly worse than the null case
• A strategy that reduces exposure when VIX is high (inverse sizing): 0.54
• A simple momentum strategy (cut exposure when the market is falling, which is typically when VIX is elevated): 0.59 — the best performer

It’s always bears repeating how risk scales:

When volatility doubles, the risk of holding stocks is actually four times as large (because variance, not standard deviation, is what matters to risk).

To merely hold your position when VIX doubles, expected returns would need to quadruple. To justify doubling down, they’d need to increase eightfold, which the authors deem practically implausible.

This post led to some smart quants chiming in on X.

Here’s @ptuomov:

This is a very low-resolution statement because each word represents many variable choices when you get into research:

Define “high”, define “trending”, “six months” was probably just a placeholder term

The degrees of freedom on the choice notwithstanding, the idea makes sense:

You are using the signals from the derivatives market, a place where leverage attracts early movers and smart money, to give a leading indicator on “the market environment is changing from the status quo” and collective anchoring biases make the wider market underreact. The way to profit from the seeds of this new information is to follow the trend.

There’s that line what the wise man does in the beginning, the fool does in the end.

The quant view is trying to find the signal of moving from the end of one cycle to the beginning of another. Trend following in a sense has a long option flavor. The premium is all the false starts and the payoff is when you finally catch a trend.

Meanwhile, buying the dip is a short option strategy in that it is betting on mean reversion as opposed to further divergence. Buying stock when VIX spikes is a mean reversion trade. But when you examine that as a strategy from the vantage point of all-time highs, it takes for granted that the mean is a good thing.

When you read a claim about a course of action, it’s good mental hygiene to first triage it as: is this directionally long or short vol?