Volatility Index What Is It, Chart, Interpretation, Criticism

The VIX has soared in April, briefly going above 60, as investors worry about the possible economic shock from global tariffs. However, the VIX can be traded through futures contracts, exchange-traded funds (ETFs), and exchange-traded notes (ETNs) that own these futures contracts. The VIX attempts to measure the magnitude of the S&P 500’s price movements (i.e., its volatility).

Myth #2: Absolute VIX Levels as Universal Signals

When its level gets to 20 or higher, expectations are that volatility will be above normal over the coming weeks. Investors, analysts, and portfolio managers look to the VIX to measure market stress before they make decisions. When the VIX is higher, this indicates greater expected volatility, which generally correlates with market fear. Market participants are more likely to pursue lower-risk investment strategies in such situations. The VIX is calculated using average weighted real-time call and put prices across the S&P 500 index with an expiration date of between 23 and 37 days out. Because the S&P 500 index represents about 80% of the value of U.S. stocks, the VIX is used as a gauge of uncertainty in the overall U.S. stock market.

These instruments allow investors to gain exposure to volatility, making it possible to manage risk more effectively or to capitalize on expected changes in market conditions without directly holding the underlying assets. CFE lists nine standard (monthly) VIX futures contracts, and six weekly expirations in VIX futures. As such, there is a wide variety of potential calendar spreading opportunities depending on expectations for implied volatility. Expressing a long or short sentiment may involve buying or selling VIX futures.

The complex nature of these derivatives means their returns can significantly deviate from what investors might expect based on VIX movements alone. While the volatility index can indicate increased market uncertainty, it does not directly predict market crashes. It provides insight into market sentiment and potential volatility, but other factors also contribute to market movements. Downside risk can be adequately hedged by buying put options, the price of which depends on market volatility.

Volatility as a Tradable Asset

All qualifying options need valid bid and ask prices to show market views on which strike prices will be met before expiry. Henry Shwartz, Vice President, Client Engagement, provides insight into recent options market activity. Enhance your proficiency in Excel and automation tools to streamline financial planning processes. Learn through real-world case studies and gain insights into the role of FP&A in mergers, acquisitions, and investment strategies. Upon completion, earn a prestigious certificate to bolster your resume and career prospects. 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).

What Does the VIX Tell Us?

Understanding the VIX can help investors stay more grounded and less reactive during a market downturn. It provides a real-time snapshot of investor sentiment and expected market volatility, offering valuable context to guide financial decisions. But it’s just one tool in making smart investment decisions for your financial future. Over long periods, index options have tended to price in slightly more uncertainty than the market ultimately realizes.

VIX Index (1 month)

The VIX, which was first introduced in 1993, is sometimes called the “fear index” because it can be used by traders and investors to gauge market sentiment and see how fearful, or uncertain, the market is. The VIX typically spikes during or in anticipation of a stock market correction. Volatility is primarily traded through financial instruments such as swaps and futures.

The more dramatic the price swings in the index, the higher the level of volatility, and vice versa. When the VIX is high, indicating increased market fear, it might signal a chance to add to positions at lower prices. Conversely, when the VIX is low, suggesting market complacency, it might be time to trim positions that have grown too large.

• Between 2020 and 2022, the price jumped from $-40 to almost $100, suggesting how external events like war and health crises can impact on the commodity.
• When its level gets to 20 or higher, expectations are that volatility will be above normal over the coming weeks.
• Downside risk can be adequately hedged by buying put options, the price of which depends on market volatility.
• But this compensation does not influence the information we publish, or the reviews that you see on this site.
• While the VIX is a valuable tool, it’s important to understand its limitations.

At that time, the index was measured as a weighted average of the implied volatility of the total eight options of the 30 days S&P 100 index. Later in the year 2003, CBOE worked in collision with Goldman Sachs and replaced the S&P 100 index with the S & P 500 index. Further, futures and options were introduced for VIX trading in 2004 and 2006, respectively. Such VIX-linked instruments allow pure volatility exposure and have created a new asset class. When considering which stocks to buy or sell, you should use the approach that you’re most comfortable with. At the time, the index only considered the implied volatility of eight separate S&P 100 put and call options.

• A falling VIX indicates that traders in the options market expect the S&P 500 Index to trade more quietly.
• The result is the VIX value, representing the market’s expectation of 30-day volatility.
• As a rule of thumb, VIX values greater than 30 are generally linked to significant volatility resulting from increased uncertainty, risk, and investors’ fear.
• The VIX typically spikes during or in anticipation of a stock market correction.

In the same respect, the lower the VIX, the lower the fear – indicating a more complacent market. Traders with a strong directional view of market volatility can use VIX futures, VIX options, or VIX ETFs to wager on their views. Finally, if VIX futures are in contango or backwardation, traders can exploit these conditions by taking positions that benefit from the roll yield. OTC leveraged products, including CFDs, are complex instruments and come with a high risk of losing money rapidly due to leverage. 61% of retail investor accounts lose money when trading CFDs with this provider.

Thus, in a bullish market, VIX is generally lower due to less volatility, and in a bearish market, VIX is higher due to unrest. Thus, there exists an inverse relationship Forex scalping strategy between market performance and the index. The years are represented on the x-axis, and the respective VIX values are represented on the y-axis. This chart will help us understand volatility index trading and the market sentiments in the market for close to two decades. As a rule of thumb, VIX values greater than 30 are generally linked to significant volatility resulting from increased uncertainty, risk, and investors’ fear. VIX values below 20 generally correspond to stable, stress-free periods in the markets.

When it’s time for a correction, « you’re holding a much heavier bag than you otherwise would have. » 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. While it’s not a crystal ball, the VIX gives investors and market professionals data for making well-informed decisions. But like any metric, it should be considered as part of a broader investment strategy.