What is the VIX | How to use the volatility index in your trades
What is the CBOE Volatility Index (VIX)?
The CBOE Volatility Index – more commonly known as the VIX – is a real-time index that tracks market expectations for changes in the S&P 500. It is an important benchmark for risk, stress and market sentiment, c This is why it is often called the “fear gauge”.
The VIX was introduced in 1993 by the Chicago Board of Options Exchange. It has grown over the years and its calculation methodology has been changed to create a broader and more accurate market benchmark.
How does the VIX work?
The VIX operates by tracking the price of at-the-money SPX options with short-term expiration dates. This means that this is not a representation of the price of the underlying S&P 500 itself, but of the price at which traders are willing to buy and sell the S&P 500 for the next month. The greater the price fluctuations in the value of SPX options, the higher the levels of market volatility and therefore the higher the VIX value.
SPX options are a combination of standard SPX options that expire on the third Friday of each month and weekly SPX options that expire every other Friday. To be included, an option must have an expiration date between 23 and 37 days from the time of calculation.
VIX calculations are complex, so in layman’s terms, the index takes the values of all puts and calls over a range of strike prices and infers the market’s perception of the strike prices that are likely to fall. be affected before the expiration date of how much people are willing to pay for each option.
The VIX is calculated in real time from 8 a.m. to 2.15 a.m. (UTC) and from 2:30 a.m. to 9.15 p.m. (UTC).
What does the VIX tell us?
The VIX tells us the market’s expectations for volatility, rather than current or historical market levels. However, it is considered a leading indicator for the wider stock market.
A common mistake when reading the VIX is that it tells us whether the S&P 500 is being bought or sold. While the VIX and the S&P 500 generally have an inverse relationship, the VIX is a measure of volatility itself – and in theory, these price movements could go either way.
Another common misconception is that VIX levels have an exact relationship to volatility seen 30 days later, when in reality the VIX level is often slightly above – or trading at a premium at – actual volatility. . In fact, when the time comes, the market has generally adapted to volatility.
How to read the VIX?
The VIX is presented as a percentage, so the indicator fluctuates between 0 and 100, much like a typical oscillator. You play the VIX using known levels of support and resistance; these are:
- Below 12 = low volatility
- Between 12 and 20 = normal volatility
- Above 20 = high volatility
There has been a traditional mantra of “When the VIX is high, it’s time to buy. When the VIX is low, look below ‘- which is used to describe these support and resistance levels.
What does it mean when the VIX goes up?
When the value of the VIX rises, it means that the price of the S&P 500 is likely to fall and the value of the SPX put options increases.
Analysts interpret these high values to mean that investors are uncertain or fearful about the stock market. The theory is that when there are high levels of volatility in the market, a low or support level has been found and the market will change direction. That is why the common action is to buy with the VIX reaching high levels.
What does this mean with the VIX descends?
When the value of the VIX goes down, it usually means that the price of the S&P 500 is rising or experiencing relative stability, leading investors in SPX options to pursue bullish or neutral strategies.
Analysts would interpret these low to mid values as a sign that the market is experiencing little stress or worry. Low VIX values are often bearish signals and lead market participants to close their positions.
How do you use the VIX?
You can use the VIX as part of a trading strategy because it can indicate whether the S&P 500, and the stock market in general, will reverse from its current trend.
As mentioned above, when the VIX hits highs it is often seen as the time to buy the market, and when it hits troughs it is seen as a bullish signal. However, this strategy should be taken into a broader technical and fundamental analysis methodology to confirm the entry and exit points suggested by the VIX.
It is important to note that the VIX may stay above or below these levels for long periods of time, so the signals it emits do not necessarily indicate an immediate reversal. For example, when the COVID-19 pandemic hit in early 2020, the VIX soared above 80 – a level it had not seen since the last financial crisis in late 2008. It took the VIX until December 2020 to fall below the 20 mark again.
The bottom line is simply that the VIX and the S&P 500 have an inverse relationship, so when the VIX rises or falls, the S&P will likely do the opposite. This makes the VIX a popular hedging tool.
How to trade the VIX
Take a position on the rise or fall of the VIX in four easy steps:
- Open an account with City Index or connect to your existing account
- Search for “Volatility Index” on our award-winning platform
- Choose your position and size, as well as your stop and limit levels
- Place trade and monitor the market
Alternatively, you can first practice trading the VIX in a risk-free environment, using our demo account.