Understanding the VIX: A Practical Guide by AAII
When you see the VIX above 30, that’s sometimes viewed as an indication that markets are very unsettled. Meanwhile, the IAI, which also has proven to be a leading indicator to the VIX, has shown some divergence. During the time period mentioned above, despite some concerns about the market, the overall IAI actually moved lower.
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The chart below shows that the market did not bottom until months after the VIX peaked in October 2008. However, in 2018, the collapse of the VXN notes caused the VIX to Quantitative Trading Systems rise in February, but it did not peak until the Q4 sell off in 2018. Of the 5 VIX spikes on the chart (se nearby table), 1 bottomed 91 days after VIX peak, another 29 days after. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates. Let’s examine the VIX, how it’s calculated, and some considerations when using it as a tool to gauge investments.
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- The VIX has paved the way for using volatility as a tradable asset, albeit through derivative products.
- This relationship underscores the importance of volatility in options trading.
- The CBOE Volatility Index—also known as the VIX—is a primary gauge of stock market volatility.
- It is an important index in the world of trading and investment because it provides a quantifiable measure of market risk and investors’ sentiments.
- To probe this a bit more deeply, we looked at how closely the VIXs predictions of volatility match the realized historical volatility 30 days later.
When a stock market moves up and down, statistical measures are used to determine just how volatile that market has been on a relative basis. This is called “historical volatility”, and is very much a rear-view mirror statistic. Cboe uses a complex calculation to arrive at the VIX—a number that changes in real-time throughout the day like stock and other index prices. The calculation takes into account the real-time average prices between the bid and ask for options with various future expiration dates. There’s more to it, but basically, the VIX is calculated as the square root of the expectation of price changes in the S&P 500 over the next 30 days.
Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request. Although the VIX revealed high levels of investor anxiety, the Investopedia Anxiety Index (IAI) remained neutral. 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. However, the VIX can be traded through futures contracts, exchange-traded funds (ETFs), and exchange-traded notes (ETNs) that own these futures contracts. Research underscores the VIX’s influence beyond U.S. borders, affecting global markets.
Some people also follow the stars, but above we have some fairly robust data. The VIX closed last night at 18.83 following a couple of days of benign movements on Wall Street. The Dow average has reached back to its 2010, pre-Greece starting point a couple of times this week but has not managed to push through. If it does push through, then maybe we could be satisfied that another leg up is underway and the VIX is right to be under 20.
Examples include the ProShares VIX Short-Term Futures ETF (VIXY) and the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX). It only provides a 30-day outlook, which may not capture longer-term trends or risks. It is also reactive, reflecting current market sentiments rather than predicting future events. Lastly, understanding and interpreting the VIX requires a good grasp of options pricing and market dynamics, which can be challenging for new investors. It seems as if the VIX reveals very little that is not already reflected in the current and past S&P 500 performance. The VIX and S&P 500 tend to be inversely related, meaning when one goes up the other goes down.
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The VIX has paved the way for using volatility as a tradable asset, albeit through derivative products. CBOE launched the first VIX-based exchange-traded futures contract in March 2004, followed by the launch of VIX options in February 2006. It then started using a wider set of options based on the broader S&P 500 Index, an expansion that allows for a more accurate view of investors’ expectations of future market volatility. A methodology was adopted that remains in effect and is also used for calculating various other variants of the volatility index.
- The Cboe Volatility Index, or the “VIX,” is a measure of the US stock market’s 30-day expected volatility—or how much and how quickly stock prices are anticipated to change.
- There are a range of different securities based on the CBOE Volatility Index that provide investors with exposure to the VIX.
- Cboe uses the real-time data from options prices and quotes on its exchange to create a measure of how much the S&P 500’s price is expected to move in the near future.
When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. This information is provided for informative purposes only and should not be construed to be investment advice. Based on the Federal Reserve of St. Louis data, a value of less than 20 could be considered relatively low, meaning that investors don’t tend to expect large future price swings. However, whether the VIX is considered low is relative and depends also on what’s been happening recently. So if the VIX is lower compared to recent levels, it may be considered a low value for that time period.
Perhaps the most straightforward way to invest in the VIX is with exchange-traded funds (ETFs) and exchange-traded notes (ETNs) based on VIX futures. As exchange-traded products, you can buy and sell these securities like stocks, greatly simplifying your VIX investing strategy. 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. Instead, investors can take a position in VIX through futures or options contracts, or through VIX-based exchange-traded products (ETPs).
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The CBOE Volatility Index (VIX) is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX). Because it is derived from the prices of SPX index options with near-term expiration dates, it generates a 30-day forward projection of volatility. Volatility, or how fast prices change, is often seen as a way to gauge market sentiment, and in particular the degree of fear among market participants.
It offers insight into how investors are pricing risk, and what that implies for future market behavior. The CBOE Volatility Index (VIX) quantifies market expectations of volatility, providing investors and traders with insight into market sentiment. It helps market participants gauge potential risks and make informed trading decisions, such as whether to hedge or make directional trades. While the VIX itself is an index and cannot be traded, there are funds and notes investors and traders can participate in to gain exposure to the index.
Experts understand what the VIX is telling them through the lens of mean reversion. In finance, mean reversion is a key principle that suggests asset prices generally remain close to their long-term averages. If prices gain a great deal very quickly, or fall very far, very rapidly, the principle of mean reversion suggests they should snap back to their long-term average before long. Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning. Following the popularity of the VIX, the CBOE now offers several other variants for measuring broad market volatility.
Different VIX traded instruments, such as VIX Exchange-traded notes (ETNs), can be used to effectively hedge risk in a portfolio. Futures and Options can yield higher potential returns, but carry more risk. To probe this a bit more deeply, we looked at how closely the VIXs predictions of volatility match the realized historical volatility 30 days later. Figure 1 shows the spread between the VIX and the rolling daily 30-day historical volatility of the S&P delayed by 30 days over a six-year period. The delay is used to compare the VIX on a given day with the volatility that was subsequently experienced over the next 30 day period. Positive values of the spread correspond to VIX over predicting realized volatility and negative values correspond to VIX under predicting the realized volatility.
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For instance, in the three months between Aug. 8, 2017, and Nov. 8, 2017, the VIX was up 19%—seemingly suggesting anxiety among market participants and implying that the S&P 500 should be on a downward trajectory. However, the S&P 500 was busy scaling all-time highs during that time frame. Volatility is one of the primary factors that affect stock and index options’ prices and premiums. As the VIX is the most widely watched measure of broad market volatility, it has a substantial impact on option prices or premiums.
Proficient use of the VIX can help investors decipher market volatility, effectively utilize timing strategies, and mitigate risks. By assessing VIX levels, investors gain understanding of market sentiment and potential future scenarios. The VIX has facilitated the trading of volatility as an asset class through derivative products. The first VIX-based exchange-traded futures contract was launched in March 2004, followed by VIX options in February xor neural network 2006.
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At Aptus, we’ve long advocated for thoughtful volatility strategies, such as owning more optionality during calm markets, and harvesting it when expectations become inflated. There are a range of different securities based on the CBOE Volatility Index that provide investors with exposure to the VIX. It’s important to note here that while volatility can have negative connotations, like greater risk, more stress, deeper uncertainty or bigger market declines, volatility itself is a neutral term. It’s simply a statistical measure of price changes for a security or an index. Greater volatility means that an index or security is seeing bigger price changes—higher or lower—over shorter periods of time. The VIX is considered a reflection of investor sentiment and has in the past been a leading indicator of a dip in the S&P 500, but Top 10 commodities that relationship may have changed in recent times.