What Is the VIX?

The predictive nature of the VIX makes it a measure of implied volatility, not one that is based on historical data or statistical analysis. The time period of the prediction also narrows the outlook to the near term. Downside risk can be adequately hedged by buying put options, the price of which depend on market volatility. Astute investors tend to buy options when the VIX is relatively low and put premiums are cheap. Volatility is one of the primary factors that affect stock and index options’ prices and premiums.

1. Experts understand what the VIX is telling them through the lens of mean reversion.
2. In other words, when the price of VIX is going up, the price of the S&P 500 is usually heading south.
3. Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only.
4. In many cases, large institutional investors will use options trading to hedge their current positions.
5. Options are derivative instruments whose price depends upon the probability of a particular stock’s current price moving enough to reach a particular level (called the strike price or exercise price).

CBOE launched the first VIX-based exchange-traded futures contract in March 2004, followed by the launch of VIX options in February 2006. As a rule of thumb, VIX values greater than 30 are generally linked to large volatility resulting from increased uncertainty, risk, and investors’ fear. VIX values below 20 generally correspond to stable, stress-free periods in the markets. Hidden Volatility happens when volatility in both the equities and options premium contracts. Sometimes in the media they will refer to this as «Greed» or «Complacency», however what is really happening is that the options premium is below and continuing to decline further than where the mean «should be». This is subjective, but can certainly be seen and experienced at its extremes.

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more – straight to your e-mail. If the VIX heads higher than 20, then fear is starting to enter into the market and it is forecasting a higher risk environment. Historically speaking, the VIX below 20 means that the market is forecasting a rather healthy and low risk environment. However, if the VIX falls too low it reflects complacency and that is dangerous, implying everyone is bullish. Remember the story of the «Shoe Shine Boy», if everyone is bullish there are no buyers left and the market comes tumbling down. This one VIX number gives us a general idea if investors are paying more or less for the right to buy or sell the S&P 500 index.

However, the index is far from perfect, and investors should consider how much weight they want to peg on it. The second method, which the VIX uses, involves inferring its value as implied by options prices. Options are derivative instruments whose price depends upon the probability of a particular stock’s current price moving enough to reach a particular level (called the strike price or exercise price).

How can I trade the VIX?

A methodology was adopted that remains in effect and is also used for calculating various other variants of the volatility index. VIX values are calculated using the CBOE-traded standard SPX options, which expire https://www.topforexnews.org/news/business-financial-news-u-s-international-breaking/ on the third Friday of each month, and the weekly SPX options, which expire on all other Fridays. Only SPX options are considered whose expiry period lies within more than 23 days and less than 37 days.

That’s why most everyday investors are best served by regularly investing in diversified, low-cost index funds and letting dollar-cost averaging smooth out any pricing swings over the long term. One of the most popular and accessible of these is the ProShares VIX Short-Term Futures ETF (VIXY), which is based on VIX futures contracts with a 30-day maturity. Large institutional investors hedge their portfolios using S&P 500 options to position themselves as winners whether the market goes up or down, and the VIX index follows these trades to gauge market volatility. The CBOE Volatility Index—also known as the VIX—is a primary gauge of stock market volatility. The VIX volatility index offers insight into how financial professionals are feeling about near-term market conditions. Understanding how the VIX works and what it’s saying can help short-term traders tweak their portfolios and get a feel for where the market is headed.

If you think the S&P is heading sharply higher then purchasing VIX put options would benefit. First it is the perception of the political and economic climate and second it is the actual fundamental soundness or the math that brings us back to reality. There is perception and mathematical reality and the VIX lies somewhere in between. In my personal opinion and from experience, based on the current geo-political environment I would say the VIX is fairly priced in the 20 point range (+/- 2).

How to Trade the VIX

However, that mean will change as economic, market, and political conditions change. The VIX is a highly touted index on CNBC and in financial circles, but what is it and what does it represent? You may hear it called the «Fear Index», but that too is a misnomer and not an accurate representation of what it is. Certainly there are times based on the price of this index that it construes fear, but other times it may reflect complacency. In the last month, major stock indexes like the S&P 500 have been pulled downward as a result of disappointing earnings reports from big tech stocks. If you’ve been following financial news, you may have heard the word «volatility» being thrown around a lot — and you may have heard a reference to a volatility measurement called the VIX.

The IAI is constructed by analyzing which topics generate the most reader interest at a given time and comparing that with actual events in the financial markets. Elizabeth Volk has been writing about the stock and options markets since 2007. Her analysis has been featured on CNBC, published in Forbes and SFO Magazine, syndicated to Yahoo Finance and MSN, and quoted https://www.day-trading.info/why-did-advanced-micro-devices/ in Barron’s, The Wall Street Journal, and USA Today. The most frequent problem that new traders have in the VIX markets is understanding its inverse relationship. It is sometimes easier to think of trading VIX options opposite of how you would trade the options in the S&P. If you think the S&P is heading sharply lower then purchasing VIX call options would benefit.

How Can I Use the VIX Level to Hedge Downside Risk?

This process involves computing various statistical numbers, like mean (average), variance, and finally, the standard deviation on the historical price data sets. The index is more commonly known by its ticker symbol and is often referred to simply as “the VIX.” It was created by the CBOE Options Exchange and is maintained by CBOE 8 efficient guaranteed ways to make your money work for you Global Markets. It is an important index in the world of trading and investment because it provides a quantifiable measure of market risk and investors’ sentiments. That said, there are plenty of VIX derivatives and exchange-traded products available for those looking to add long or short volatility exposure to their portfolios.

It is driven more by the perception and human condition of fear and greed, than by any other force. Instead, investors can take a position in VIX through futures or options contracts, or through VIX-based exchange traded products (ETPs). Now, for example, suppose the level of uncertainty in the market increases, and options premiums are now higher. Traders who felt the volatility was too high and would soon fall would begin selling options.

You might consider shifting some of your portfolio to assets thought to be less risky, like bonds or money market funds. Alternatively, you could adjust your asset allocation to cash in recent gains and set aside funds during a down market. Generally speaking, if the VIX index is at 12 or lower, the market is considered to be in a period of low volatility. On the other hand, abnormally high volatility is often seen as anything that is above 20. When you see the VIX above 30, that’s sometimes viewed as an indication that markets are very unsettled. Although the VIX revealed high levels of investor anxiety, the Investopedia Anxiety Index (IAI) remained neutral.

Past performance of a security or strategy does not guarantee future results or investing success. This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research. Our partners cannot pay us to guarantee favorable reviews of their products or services.

In addition to VIX options, various VIX-based exchange-traded products (ETPs) exist that track the price action of the index itself and/or some combination of its futures – whether directly, inversely or in a leveraged manner. Some of the more popular and active of these include the iPath Series B S&P 500 VIX Short Term Futures ETN (VXX), the ProShares Ultra VIX Short-Term Futures ETF (UVXY), and the Short VIX Short-Term Futures ETF (SVXY). Given the differing factors driving the day-to-day action in each index, VIX and SPX are generally expected to maintain an inverse correlation with one another. It is important when trading VIX products that one understands its inverse relationship to the equity markets. The VIX will usually rise in value (price) as the stock market (primarily the S&P index) declines. As the range of strike prices for puts and calls on the S&P 500 increases, it indicates that the investors placing the options trades are predicting some price movement up or down.