What the VIX Tells Us and How to Trade It

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). However, that mean will change as economic, market, and political conditions change. 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 in Barron’s, The Wall Street Journal, and USA Today. 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.

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VIX values are quoted in percentage points and are supposed to predict the stock price movement in the S&P 500 over the following 30 days. The VIX formula is calculated as the square root of the par variance swap rate over those first 30 days, also known as the risk-neutral expectation. This formula was developed by Vanderbilt University Professor Robert Whaley in 1993. 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.

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The VIX options and futures can be used to both hedge a long portfolio or even used to take a position in the VIX. 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”.

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Remember, there is a risk of loss, with trading options and futures, so trade with risk capital only. Following the popularity of the VIX, the CBOE now offers several other variants for measuring broad market volatility. Examples include the CBOE Short-Term Volatility Index (VIX9D), which reflects the nine-day expected volatility of the S&P 500 Index; the CBOE S&P Month Volatility Index (VIX3M); and the CBOE S&P Month Volatility Index (VIX6M). Products based on other market indexes include the Nasdaq-100 Volatility Index (VXN); the CBOE DJIA Volatility Index (VXD); and the CBOE Russell 2000 Volatility Index (RVX). All in all, the VIX is a powerful thing to trade and can either work for you or against you just like any stock or currency.

Such volatility, as implied by or inferred from market prices, is called forward-looking implied volatility (IV). I am not a licensed financial advisor, and any information shared or discussed is not to be construed as investment advice. Trading and investing involves a degree of risk, and is not suitable to all investors. Please consult with your financial advisor before making any sort of investment decisions. The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice.

In addition to being an index to measure volatility, traders can also trade VIX futures, options, and ETFs to hedge or speculate on volatility changes in the index. 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 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. Securities or other financial instruments mentioned in the material posted are not suitable for all investors.

The risk of loss in online trading of stocks, options, futures, forex, foreign equities, and fixed income can be substantial. Before trading, clients must read the relevant risk disclosure statements on IBKR’s Warnings and Disclosures page. JD Henning is a Finance PhD, MBA, investment adviser, fraud examiner and certified anti-money laundering specialist with more than 30 years trading and investing stocks and other securities. JD runs Value & Momentum Breakouts where he identifies identify breakout signals and breakdown warnings using technical and fundamental analysis. It should be noted that these are rough guidelines ⏤ unexpected events can throw a wrench into markets and a low VIX level today could be followed by a period of extreme volatility if circumstances change.

Such VIX-linked instruments allow pure volatility exposure and have created a new asset class. Before the stock market crash in March, the VIX was trading under $20. When fears rose due to the pandemic and the government announced a temporary economic shutdown, it jumped up to as much as $80. When we saw the VIX at $80, investors knew that fear had taken over lots of money had been taken out of the market. Supposedly, it measures volatility, but from what I’ve gathered, it behaves as if one were to short the market.

The time decay works in favor of the position but each hedge trade eats into profits as they buy high and sell low, so the fewer of them that occur, the better. To hedge a long portfolio one could purchase call options or take a long VIX future position. The general idea is if the long portfolio declines sharply in price the VIX will rise in price and the call options would increase in value. Our job as investors, traders, and risk managers is to understand what it is and what it isn’t – to find and estimate a range of accuracy and then determine if human fear or greed is driving it to one extreme or 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 https://forexbroker-listing.com/cmc-markets/ the S&P index) declines. Remember the VIX is not set by any one person or even groups of people; it is solely determined by order flow of all buyers and sellers of options.

The VIX, formally known as the Chicago Board Options Exchange (CBOE) Volatility Index, measures how much volatility professional investors think the S&P 500 index will experience over the next 30 days. Market professionals refer to this as “implied volatility”—implied because the VIX tracks the options market, where traders make bets about the future performance of different securities and market indices, such as the S&P 500. The levels of implied volatility across a wide range of options were historically low, almost freakishly so. We see a very different setup now, with rampant call speculation pushing implied volatilities – particularly on out of the money calls – to levels above historic norms.

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Also, when the underlying S&P 500 index is moving with frequency and magnitude, traders are more willing to hold long options positions because of the profitable hedging activity. When the index is not moving much, traders lower the volatility input to their models to avoid holding unprofitable long positions or even switch to a more advantageous short position. The percentage value quoted in the VIX represent the size of a one standard deviation move over one year in the S&P 500 index. Pricing models assume the normal distribution of returns, so a VIX reading of 16% means the options markets are pricing in a 68% chance that the index will be within 16% of it’s current level one year from now. During winter 2013, a time of strong stock market performance, the VIX was at around 12. But in March 2020, as a global panic about the COVID-19 pandemic peaked, the index reached a record 82.69.

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. Since the possibility of such price moves happening within the given time frame is represented by the volatility factor, various option pricing methods (like the Black-Scholes model) include volatility as an integral input parameter. Since option prices are available in the open market, they can be used to derive the volatility of the underlying security.

For those wanting to trade markets using computer-power by coders and developers. The bank has not suffered any trading losses due to the XIV implosion. Nevertheless, the Swiss lender this morning set a redemption date of Feb. 20, for the volatility note, well ahead of the Dec. 4, 2030, maturity date. The offers that appear on this site are from companies that compensate us. But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you.

The reverse is true when the market advances—the index values, fear, and volatility decline. In the past year of trading days, the VIX has risen 10% or more on 12 different occasions. In eight of those 12, the following week has seen the S&P 500 rise, with an average of .93% over the five-day span. For example, September 5th, the VIX closed 20% higher than the previous trading day. Monday of the next week the S&P closed 1.08% higher and continued to be green most of the rest of the week.

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The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments. 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 that relationship may have changed in recent times. 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.

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. One simple way to pick your entries on the VIX are by looking at the https://broker-review.org/ market’s relative strength. When the 14-Day RSI is above 70 (overbought) you will usually see some increase in price in the short term. Any information posted by employees of IBKR or an affiliated company is based upon information that is believed to be reliable.

ETNs in particular can be less liquid and more difficult to trade as well as may carry higher fees. During its origin in 1993, VIX was calculated as a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options, when the derivatives market had limited activity and was in its growing stages. VIX values are calculated using the CBOE-traded standard SPX options, which expire on the third Friday of each month, and the weekly SPX options, which expire on all other Fridays.

But what makes it special is that when the market is losing money, you could be making money. It’s not only an index you can trade, but it’s also an indicator in itself. What I like to point out here is that the VIX clearly has more upside potential than to the downside. If you entered the trade at the $20 mark, the risk to reward was immensely in your favor. In hindsight, if you were to purchase one share of the VIX on February 21 and got in around $18, you were either risking all of your $18 for the potential of making $67.40. Coincidentally, the VIX took about four times as long to return to pre-crash levels.

Especially in things like TVIX; your money will move at double the volatility in the VIX. TVIX just means 2X leverage which can either work out very well or very poorly for you. The line in orange represents the VIX and the candles are the Dow Jones Industrial Average. Notice the blue dotted line showing how RSI was above 70 on DJI before we saw an increase in the VIX. To me, RSI is one of the best indicators that tell you when stocks are over or under valued.

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. Miranda Marquit has been covering personal finance, investing and business topics for almost 15 years. She has contributed to numerous outlets, including NPR, Marketwatch, U.S. News & World Report and HuffPost. Miranda is completing her MBA and lives in Idaho, where she enjoys spending time with her son playing board games, travel and the outdoors. Options and futures based on VIX products are available for trading on CBOE and CFE platforms, respectively.

NerdWallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances. Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Our estimates are based on past market performance, and past performance is not a guarantee of future performance. The most significant words in that description are expected and the next 30 days.

1. There are a range of different securities based on the CBOE Volatility Index that provide investors with exposure to the VIX.
2. The levels of implied volatility across a wide range of options were historically low, almost freakishly so.
3. 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.
4. Whenever the VIX dips below 20, the stock market marks a medium-term top.
5. The responses to each one of the similar prior historical events also serve to remind us that there is tremendous value to be found in the long term future of our publicly traded companies.

However, we are in times where uncertainty is high and fears of another shutdown are in the back of everyone’s mind. You can expect heavy volatility for a while as the US government tries to figure out what to do about the economy. And risk to reward looks very good right now for the VIX, but it all depends on how much one wants to risk. Some traders have made millions on trading calls and put options on this index, but that requires perfect timing. If you’re more confident about ‘where’ instead of ‘when’, you can just purchase shares of the VIX without having to worry about an option call that expires after a given time. That much is understood by most investors, but what exactly is volatility and how is it measured for the overall stock market?

The more opportunities the trader gets to hedge, the more likely it is that the accumulated profits from those hedge trades will exceed the amount that the options decay, resulting in a profit. That trader would prefer frequent movement in either direction and thus, more chances for profitable hedge trades. That’s closer to what most traders and market makers in index options care about. First introduced by the Chicago Board Options Exchange (Cboe) in 1993, the initial version of the VIX reflected a rolling 30-day calculation of at-the-money implied volatility (IV) on S&P 100 Index (OEX) options. This calculation is no longer widely used or tracked, but the “old VIX” is still available under the ticker symbol VXO. Investopedia does not provide tax, investment, or financial services and advice.

But to understand how the Volatility Index works, it’s helpful to have a basic understanding of options trading. When you purchase options, you’re buying the right (but not the obligation) to buy or sell a stock at a specified date and price. In times of uncertainty, investors will pay a premium for what’s essentially a form of insurance.

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. The VIX index tracks the tendency of the S&P 500 to move away from and then revert to the mean. When the stock markets appear relatively calm but the VIX index spikes higher, professionals are betting that prices on the S&P 500—and thereby the stock market as a whole—may be moving higher or lower in the near term. When the VIX moves lower, investors may view this as a sign the index is reverting to the mean, with the period of greater volatility soon to end. There are a range of different securities based on the CBOE Volatility Index that provide investors with exposure to the VIX.

Instead, investors can take a position in VIX through futures or options contracts, or through VIX-based exchange traded products (ETPs). The CBOE Volatility Index, otherwise known as the VIX, is a volatility indicator that measures the expected volatility in the next 30 days. It’s often called the ‘fear index’ by investors as it shows whether it’s time to buy or sell stocks.

While there have been a few spikes in the index, often times they are short-lived and followed by an equal drop. The VIX has the same human flaw of perception that is found in the equity markets that frequently drive stock velocity trade prices too high or too low. Human perception can quickly lead to greed or fear, rather than focusing on the math and fundamentals. Logic, reason, and wisdom are cast aside as we are driven by irrational greed or fear.

The VIX is not set by any one person, but rather the results of millions of transactions by millions of traders from around the world. The buyers and sellers move the option prices, more buyers and the premiums go up, more sellers and the premiums go down. The VIX takes a weighted average of all these options prices in the S&P 500 index and derives a single number that is called the VIX.