One could extrapolate an equilibrium level, where the market (risk premium) is fairly priced based on the economic landscape. For those interested in what the number mathematically represents, here it is in the most simple of terms. The VIX represents the S&P 500 index +/- percentage move, annualized for one standard deviation. That means, based on the option premiums in the S&P 500 index, the S&P is expected to stay with in a +/- 15% range over 1 year, 68% of the time (which represents one standard deviation). It is a good indicator of the expectation of market volatility, note I said “expectation”, it is not representative of the actual volatility or what will happen.
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- However, it spiked far beyond reality as panic drove option premiums (insurance prices) into the stratosphere.
- The time period of the prediction also narrows the outlook to the near term.
As the VIX is the most widely watched measure of broad market volatility, it has a substantial impact on option prices or premiums. A higher VIX means higher prices for options (i.e., more expensive option premiums) while a lower VIX means lower option prices or cheaper premiums. Active traders who employ their own trading strategies and advanced algorithms use VIX values to price the derivatives, which are based on high beta stocks.
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This calculation is no longer widely used or tracked, but the “old VIX” is still available under the ticker symbol VXO. The VIX is typically used to measure short-term investor sentiment, but many also use the index as a foundation for active investing strategies. Before purchasing a security tied to an index like the VIX, it’s important to understand all of your options so that you can make educated decisions about your investment choices. If you’re interested in investing in a VIX ETF/ETN, we recommend that you speak with a financial professional first to make sure your investment strategy fits your needs. Sentiment plays a big role in decision making for the stock markets, and to that extent, it could be a good idea to glance at the VIX.
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. The VIX, formally known https://www.topforexnews.org/brokers/xemarkets-to-hold-a-live-seminar-at-lse/ 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.
When investors trade options, they are essentially placing bets on where they think the price of a specific security will go. In many cases, large institutional investors will use options trading to hedge their current positions. So, if the big firms on Wall Street are anticipating an upswing or downswing in the broader market, they may try to hedge against that volatility by placing options trades. If many of the large investment firms are anticipating the same thing, there is usually a spike in options trading for the S&P 500. The VIX index uses the bid/ask prices of options trading for the S&P 500 index in order to gauge investor sentiment for the larger financial market. It gives a current and accurate measure of where options premium in the S&P 500 index is trading.
How to Trade the VIX
The VIX attempts to measure the magnitude of price movements of the S&P 500 (i.e., its volatility). The more dramatic the price swings are in the index, the higher the level of volatility, and vice versa. 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.
Evolution of the VIX
The Cboe Volatility Index – frequently referred to by its ticker symbol, VIX – is a real-time measure of implied volatility on the benchmark S&P 500 Index (SPX). Not only is the VIX used as a quick gauge of short-term investor sentiment, it’s also the basis of many active investing strategies, from portfolio hedging to directional speculation. There are a range of different securities based on the CBOE Volatility Index that provide investors with exposure to the VIX. The most significant words in that description are expected and the next 30 days.
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. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more.
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All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. Put it in your calendar the difference between data and information in health care today to make watching the VIX part of your trading routine. At these tails of extreme there are huge opportunities, for one must see others’ fear or greed as an opportunity and not be sucked in like the rest of the lemmings.
The VIX is considered a reflection of investor sentiment, but one must remember that it is supposed to be a leading indicator. In other words, it should not be construed as a sign of an immediate market movement. 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). The VIX has paved the way for using volatility as a tradable asset, albeit through derivative products.
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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. The VIX options and futures can be used to both hedge a long portfolio or even used to take a position in the VIX. As an investor, if you see the VIX rising it could be a sign of volatility ahead.
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. Options and futures based on VIX products are available for trading on CBOE and CFE platforms, respectively.
Beta represents how much a particular stock price can move with respect to the move in a broader market index. For instance, a stock having a beta of +1.5 indicates that it is theoretically 50% https://www.day-trading.info/blog/ more volatile than the market. Traders making bets through options of such high beta stocks utilize the VIX volatility values in appropriate proportion to correctly price their options trades.