To The Moon

When will $S&P 500(.SPX)$ and $Cboe Volatility Index(VIX)$ plunge in convergence?

A conclusion: when the SPX has been falling for close to a month (30 days or so), the "momentum" of the VIX decreases dramatically, and if the market does not have an "extreme selloff" (e.g., a meltdown) or if the market does not expect a selloff (implied volatility is extremely high), the VIX could fall in tandem with the SPX.

Why would such a scenario occur?

Composition of the VIX Index

The VIX Index is compiled by $Cboe Global Markets, Inc(CBOE)$ to reflect the market's expectation of volatility over the next 30 days through the implied volatility of options on the S&P 500 Index (SPX).The core of its calculation rules are:

• Options: Only near-month and sub-near-month options (including weekly contracts) with expiration dates between 23 and 37 days are included, and contracts with illiquid or invalid quotes are excluded.

• Model-free weighting: Implied volatility is weighted by combining call and put option prices with different strike prices using the principle of model-free variance swaps.The formula synthesizes 30-day expected volatility through time adjustment (weight allocation between near-month and sub-near-month contracts).

• Annualized Treatment: The final reading is presented as an annualized standard deviation.For example, with a VIX of 16, the market expects the SPX to have an annualized volatility of ±16% over the next 30 days.

Scenario Mechanisms for Synchronized VIX and SPX Declines

Although the two, VIX and SPX, usually show a negative correlation (correlation coefficient of about -0.73), they fall in the same direction on about 20% of trading days, and the main scenarios include:

• Slow decline and volatility convergence: when the SPX declines but intraday amplitude narrows (e.g., March 12, 2025 when the SPX edges up 0.49% but the VIX plummets 10%), the market expects that the peak in volatility has passed and that panic is diminishing at the margin.

• Expectations stabilize: if economic data (e.g., CPI, PPI) is better than expected (CPI fell to 3.1% y/y in March 2025) and investor concerns about Fed policy uncertainty ease, the VIX could still fall back even if the SPX pulls back.

• Investors have a trending shift in hedging strategies: investors hedge their risk by actively reducing their positions rather than purchasing puts (e.g., the VIX only rises from 22.78 to 23.37 in the March 2025 market sell-off), curbing the volatility index's upward movement.

Typical case:

1. March 2020 stock indexes open with a generalized drop of about 3% and the VIX is down over 3% (at this point it has been down for 1 month due to the COVID-19 panic)

2. On March 12, 2025, the SPX rises slightly by +0.49%, but the VIX falls by -10% (at this point, the market shifts from "panic selling" to "restorative shock")

Derivatives risk of the VIX

Since the VIX is not directly tradable and relies mainly on futures and options, secondary market investors are more likely to trade it through exchange-related products, such as ETNs and ETFs, but there are structural differences and risks: the VIX is not directly tradable, but mainly relies on futures and options.

Meanwhile, the futures basis effect: VIX futures are at Contango (forward premium) for a long period of time, causing ETNs/ETFs to continually roll over contracts at high prices, resulting in time loss.For example, $iPath Series B S&P 500 VIX Short-Term Futures ETN(VXX)$ has accumulated a loss of 99.96% since its launch in 2009, highlighting the structural risk.

Current Market Environment and VIX Trading Strategies

SPX From March 10-14, the S&P 500 fell 2.27% to 5,504, nearly 10% off its February high, but the VIX only rose from 22.78 to 23.37, with no significant rise in panic.The three days from March 16-March 19 were largely sideways, with the VIX dropping even more by 9%.

Core factors included

1. Trading strategy change: expectations of a Fed rate cut (supported by CPI data) overlaid with Trump tariff shock (March steel and aluminum tariffs triggered a 20% one-day jump in the VIX), with the market responding to the risk through position management rather than options hedging.

2. Futures structure: Mid- to long-term VIX futures (e.g., April-July contracts tracked by $ProShares VIX Mid-Term Futures ETF(VIXM)$ ) have weaker correlation with spot VIX due to lower rollover costs and more stable volatility expectations.

3. Funding behavior: programmed trades (e.g., volatility targeting strategies) trigger automatic position reductions at high volatility thresholds, dampening VIX spikes.

Hence the strategic takeaways for the present

Short term: if SPX declines narrow or go sideways, VIX could continue to move lower due to volatility mean reversion, while derivatives will continue to deplete due to VIX futures Contango structure.

Medium term:

1. SPX real puts (e.g., strike 6750, 331-day expiration) are cheaper to hedge if a slow decline in the SPX continues to be expected;

2. VIX dummy calls (e.g., strike 30, 55-day expiration) are more explosive during a panic crash.