By Whitney Kisling

March 16 (Bloomberg) — The most popular measure of expected swings in the stock market is all but useless for forecasting the direction of equity prices, according to a study from Birinyi Associates Inc.

Lower-than-average readings in the Chicago Board Options Exchange Volatility Index, interpreted by investors as a bullish sign for stocks, precede both gains and losses during the next 60 days, according to data compiled by Birinyi, a Westport, Connecticut-based research firm that oversees about $300 million in assets. Higher levels in the measure known as the VIX usually give way to gains over the next three months, a finding that is contrary to conventional wisdom, the firm said.

Traders use the VIX as a gauge of investor fear because it’s derived from the cost of options that insure against losses from stocks. Birinyi’s research found that the index has little to no real connection to future equity prices and instead tends to move in lockstep with shares.

“The VIX is a coincidental indicator with limited predictive value,” according to the study by Laszlo Birinyi and analyst Kevin Pleines that was released today. “It details, perhaps better than other measures, the volatility of the market today but not tomorrow or the day after.”

The VIX has fallen 18 percent to 17.69 so far in 2010. That’s below the average reading of 20.3 during the measure’s two-decade history. Options are derivatives that give the right to buy or sell assets at a set price by a specific date.

Implied Volatility

The index is supposed to gauge investor expectations for market swings over the next 30 days using a formula that incorporates implied volatility, a key measure of options prices, for Standard & Poor’s 500 Index puts and calls that are one or two months from expiration. Puts give owners the right to sell an underlying security, and calls convey the right to buy.

Extreme high or low readings aren’t accurate reflections of future prices because they are both followed by higher stock prices 90 days later, according to the Birinyi report.

After the VIX climbed to a record high of 80.86 on Nov. 20, 2008, the S&P 500 advanced 11 percent through April 2, 2009, according to data compiled by Bloomberg. The VIX sank to a 13- year low of 9.89 on Jan. 24, 2007, and the S&P 500 then rose 6.9 percent through June 4, 2007.

Birinyi analyzed the VIX’s performance since September 2003, including six periods of what he called “extreme” volatility, including the November 2008 record. He analyzed 12 times when the VIX fell 20 percent below its 50-day average and 18 periods when it was 20 percent above since 2003. The following is a table of the S&P 500’s average gain or loss during subsequent periods:

1 Month 2 Months 3 Months 6 Months
VIX 20% Below 0.09% -0.49% 3.33% 5.84%
VIX 20% Above 1.25% 0.50% 0.95% -4.51%

Source: Birinyi Associates