VIX: The CBOE volatility index
VIX (since 1993), in contrast with the common perception, doesn’t measure fear or present volatility of market but rather the future expectation of the market’s volatility. This volatility is implied by the SPX options prices in the next 30days.
VIX tells you the expectation or perception of risk and uncertainty. Although, it is not an exact science, this volatility index is fairly reliable and used by most professional traders.
Similar to put options, the best way to look at VIX is thru the eyes of a person who needs to get his house or car insured.
He or she would want to pay a lot more for the insurance policy in the time of high uncertainty or high-probable coming disaster.
As the demand for the options in SPX increases or decrease, VIX will adjust itself accordingly.
When VIX begins to head down, people are less willing to pay for SPX options and the general board market options.
VIX and SPX movement depend on each trading day’s market action. However, VIX and SPX don’t always move inversely.
Sometimes, you see VIX spiking up in the expectation of traders but perception is just perception, fear could ease suddenly and market moves in opposite direction.
If you recalled the time of extreme market condition in late 2009, the US government stepped in bail-out banks and others company, market started to settle down. But VIX didn’t begin to fall until a number of following trading days.
One way traders use this index options is hedging the portfolio in non-volatile market should they expect the market to fluctuate wildly in the days or months to come.
Other way to use it is as a contrarian indicator. The old saying goes:” VIX is higher, time to buy; VIX is low, time to go (sell)”.
Again, not an exact science. You have to test your own high and low.
For most professional traders, the 30 mark is the barrier of the bulls and bears.
Category: VIX Volatility Index
