VIX Has Reached a Level That Normally Precedes an Uptick in Volatility

We all know the VIX is very low; this fact has been talked about ad nausea lately.  And by looking at the yellow bands, the volatility contraction is rather clear. I'm not so much concerned with how low the actual price (static) is, but more with the relative price action (dynamic). Today I'm using Bollinger Bands to observe a potential short term extreme in the $VIX. The definition and explanation of Bollinger Bands can be found on the creator's website. Bollinger Bands ("BB") are one measure of volatility; so why not measure the volatility of volatility (via the VIX).  You can set this indicator to measure just about any period length and standard deviation, but right now I'm just looking at 20 periods and 2 standard deviations (this is the default parameter BTW).

On 1-14-11, the VIX closed below its BB (20,2). When it touches this level, where does volatility (VIX) usually head over the next week?

Buy VIX when it close below Bollinger Band (20,2) ; sell 'n' days later. $10,000 per trade; 1995 to present.
Exit n  days	Net Profit	# Trades	# of winners	% of Winners	Max. Trade % DD	Avg % P/L	W. Avg. Profit	L. Avg. Loss	Profit Factor	Payoff Ratio
1	19,055.92	80	53	66.25	-5.96	2.38	490.59	(257.23)	3.74	1.91
2	36,353.22	72	60	83.33	-8.55	5.05	690.55	(423.30)	8.16	1.63
3	41,257.07	70	51	72.86	-11.87	5.89	917.59	(291.57)	8.45	3.15
4	45,586.29	70	52	74.29	-13.92	6.51	1,005.72	(372.84)	7.79	2.70
5	47,518.96	66	45	68.18	-16.27	7.20	1,266.88	(451.94)	6.01	2.80

Over the last 15 years, if you could buy [you can't though because it's not tradable as an index] the VIX when it hit this level, you could've made money holding anywhere from 1 to 5 days. Bottom line: odds point to an increase in volatility this week. With all the new VIX products out there, there are many new ways to play the VIX action - so have at it!

Now since the S & P 500 and VIX usually work inversely to each other, here's how the SPY performed when the VIX hit the low level like it did on Friday.

Buy SPY when VIX closes below Bollinger Band (20,2) ; sell 'n' days later. $10,000 per trade; 1995 to present.
Exit n  days	Net Profit	# Trades	# of winners	% of Winners	Max. Trade % DD	Avg % P/L	W. Avg. Profit	L. Avg. Loss	Profit Factor	Payoff Ratio
1	(286.61)	80	36	45.00	-3.32	-0.04	70.01	(63.79)	0.90	1.10
2	(2,009.39)	72	33	45.83	-4.74	-0.28	85.16	(123.58)	0.58	0.69
3	(3,186.98)	70	34	48.57	-5.79	-0.46	90.56	(174.05)	0.49	0.52
4	(3,381.93)	70	34	48.57	-5.85	-0.48	86.29	(175.44)	0.46	0.49
5	(4,630.95)	66	29	43.94	-6.72	-0.70	103.73	(206.46)	0.39	0.50

              
The SPY has not performed too well under these conditions. You don't get killed, but it's probably not the best time to go heavy on the long side.

These are some things to keep in mind for this upcoming (holiday shortened) week. Remember to consider your own relevant trading factors before acting and that the past doesn't always predict the future .

Good trading out there.
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Extra tidbit:

One extreme to the next: If you had the intestinal fortitude to buy the VIX on a close below BB (20,2) but sold only when it closed above BB (20,2), here is how it would go. (Average hold is 30 days)

Buy when VIX when on close below BB (20,2); sell on close above BB (20,2) $10,000 per trade; 1995 to present.
	Net Profit	# Trades	# of winners	% of Winners	Max. Trade % DD	Avg % P/L	W. Avg. Profit	L. Avg. Loss	Profit Factor	Payoff Ratio
1	89,869	43	37	86.05	-41.33	20.90	2,648	(1,349)	12.10	1.96