Better Watch Out, Better not Cry…the Vomma Zone is Here

One the indicators that we look at closely at TheoTrade is when the VVIX crosses over into the “Vomma Zone.” Now, you’ve probably never heard of the Vomma Zone and you may not have heard of the VVIX. However, this is a key indication of potential volatility in the S&P 500 around the corner. This is an indication that helps traders prepare for when volatility comes to town.

What is the Vomma Zone?

The CBOE VVIX Index (VVIX) is like a second order derivative of volatility or vomma. This is because it measures the expected movement in the VIX and not the underlying S&P 500 Index (SPX). As a result, it is similar to the option Greek “vomma” that measures the rate of change in vega. What we term the Vomma Zone, is a critical area for the VVIX that signals potential for major movement in the VIX and the SPX.

Where is this threshold you ask?

When the VVIX crosses above 110, this is major signal that institutions are using VIX options to hedge the potential downside risk in the market. When there is a surge in call buying, this causes the VIX options to become more expensive and, as a result, causes the VVIX to rise.

There is one other important understanding to grasp the significance of this. That is that the VIX mostly moves inverse to the S&P 500. The skewed nature of SPX returns means that the market crashes downward. As a result, hedges are needed to protect against the crash risk of the broader market. This causes the VIX to rise as the SPX falls.

One important note about the VVIX is that it will frequently rise into the Vomma Zone before a move lower. This happens as institutions begin to price in the potential move lower in the market as they hedge their risk into strength.

Vomma Zone History

 Looking at the past year, the VVIX has crossed into the Vomma Zone six times, including yesterday. In four of the five instances, the S&P was about to make a major move lower. Here are the dates:

  • February 24, 2020
  • June 8, 2020
  • August 10, 2020
  • August 27, 2020
  • October 13, 2020
  • December 9, 2020

The chart below is a plotting the VVIX (Black) with these crossovers highlighted along with the SPX (Purple).

Over the past year, this one signal alone would have notified you of four significant corrections in the market. Think about what you would have done knowing that there are significant expectations of a major volatility event in the market just around the corner.

At TheoTrade, we not only teach you about the Vomma Zone, but ways to exploit it from a trading standpoint and how to hedge it. This is a potentially huge addition to an investor and trader’s arsenal of strategies.

Conclusion

The VVIX crossing into the Vomma Zone is a major event that happened yesterday. However, it wasn’t the only one. The major point here is that it is likely the easiest way to identify these shifts in sentiment and expectations. Adding this as part of your analysis can open the door to understanding market expectations and being able to know when to hedge downside risk in the market along with the “smart money.”

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1 Comment

  • JackieW

    December 13, 2020

    Obviously this should be renamed to the "Vomit Zone"! 🙂