VIX Explained

For people watching the VIX index, it’s understood that the S&P 500 stands in for “the stock market” or “the market” as a whole. When the VIX index moves higher, this reflects the fact that professional investors are responding to more price volatility in the S&P 500 in particular and markets more generally. When the VIX declines, investors are betting there will be smaller price moves up or down in the S&P 500, which implies calmer markets and less uncertainty.

1. It is important when trading VIX products that one understands its inverse relationship to the equity markets.
2. This process involves computing various statistical numbers, like mean (average), variance, and finally, the standard deviation on the historical price data sets.
3. The VIX suffered huge whipsaws in 2009, 2010, and 2011 trying to over compensate and find some realm of equilibrium between perception and math.
4. Downside risk can be adequately hedged by buying put options, the price of which depend on market volatility.
5. The buyers and sellers move the option prices, more buyers and the premiums go up, more sellers and the premiums go down.

If the VIX is rising, demand for options is increasing and therefore becoming more expensive. If the VIX is falling, there’s less demand and options prices tend to fall. I have a saying known as “Hidden Volatility”; this is when the market premium [options premium] contracts as the equity markets start to consolidate.

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Again, during the crisis the VIX would have us believe that all is well and that the S&P 500 index has a very low probability of making any radical moves, again the VIX was wrong and it moved back up. The VIX is a number derived from the prices of options premium in the S&P 500 index (which is an index comprising 500 large cap stocks). 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. 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. 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.

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

For example, on Nov. 9, 2017, the VIX climbed 22% during the trading session on fears of delays in the tax reform plan. 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.

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. https://www.day-trading.info/how-to-find-momentum-stocks-momentum-the-most/ 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. 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.

What Does the VIX Tell Us?

This is a very important point; it is just a general assumption based on the premiums investors are willing to pay for the right to buy or sell stock. The formula used by Cboe to calculate the price of VIX is rather complex, and the price of VIX is updated live during trading hours every 15 seconds. To spare you the math headache involved with calculating the price, let’s look instead at the data used to calculate it. The VIX index is specifically measuring expected volatility for another index, the S&P 500. True to its name, the S&P 500 index is composed of 500 of the largest publicly traded companies in the U.S. Because the S&P 500 includes so many large companies across several different market sectors, it is generally viewed as a good indication of how the U.S. stock market is performing overall.

Closing Market Update

However, it is very important that we understand that the VIX is not right or wrong in its current or forecast measurement of S&P 500 volatility. It is just where the market is willing to trade the premium or current measurement of risk. At the extremes we see that it is wrong and quickly tries to compensate, as buyers quickly become sellers or sellers quickly turn into buyers.

The VIX was the first benchmark index introduced by CCOE to measure the market’s expectation of future volatility. In fact, recognizing high implied volatility is one way market makers create their positions. Accordingly, market makers often sell options when implied volatility is high in an attempt to allow time decay to create their profits. Investors look to the Cboe Market Volatility Index, or the VIX, to determine the implied volatility levels for the overall market.

We know that the market will not consolidate [form a wedge] indefinitely and when it does break out (up or down), it could be a violent move. We cannot see the energy in that spring, but we know it is there and when the energy is finally released it moves fast and violently. How much power is needed and How to start working with Power Trend how long that power can last to keep that spring contracted is something that physics can answer; however, in the market that equation is driven by supply and demand. In many cases it is a catalyst event that unleashes the power as one side steps away and forces the other side into full capitulation.

If we look at historical points of the VIX we see that during the height of the great housing crisis in 2008 and 2009 the VIX rocketed to levels far above 50. For our understanding of the model, the options are pricing that the S&P 500 index (the largest 500 companies) will be in a range of +/- 50% over the year, 68% of the time. The VIX quickly came falling back down and then went too far the other way and fell below 15.