What Is VIX and the VIX Index?
VIX and VIX investment products are a relatively new asset class that is available to investors via futures contracts, options and VIX ETNs.
Like commodities, stocks or bonds, volatility is now seen as an asset class that can be used for portfolio diversification, hedging or directional investing. Volatility offers fast moving opportunities for investors but requires a sound trading program, risk management and discipline to succeed.
VIX is the CBOE S&P 500 Volatility Index, also known as the “Fear Index,” and it tracks predicted volatility of the S&P 500 over the next 30 days.
VIX prices are based on S&P 500 Index options and reflect prices that traders and speculators are willing to pay for options between the current date and the date of the specific option expiration.
If volatility is low, options prices will be low and if volatility is high, related options prices will be high as well and so one can draw inferences about expected volatility of the S&P 500 over the next 30 days.
VIX prices tend to move opposite the S&P 500 so when the S&P 500 gains in value, VIX will generally fall, and when the S&P 500 declines in value, VIX will generally rise.
The rate of change of VIX is generally 3-4 times the S&P 500 so if the S&P 500 gains 1%, VIX will lose in the neighborhood of 3-4%.
VIX is updated continually throughout the trading day and so offers a real time view of anticipated volatility by some of the most sophisticated traders in the world.
It was initially introduced in 1993 and a second version was launched in 2003 and that is the one that is still in use today.
VIX is used in many different ways. Some see it as a predictive measure of market risk and future movement of the S&P 500 while others think it is reactive in nature and so can only paint the current picture of market volatility.
chart courtesy of stockcharts.com
VIX is charted on a scale from 1 to 100 with higher levels indicating increased volatility and lower levels indicating lower volatility. High volatility is associated with increased risk in the market while lower volatility indicates complacency and quiet conditions.
In the chart above, we can see how VIX spiked during the Financial Crisis of 2008-2009 and then dropped to near historically low levels in response to the Federal Reserve’s quantitative easing program and the bull market that started in 2009.
The chart also plainly depicts how VIX is mean reverting rather than trend following and so most trend following trading systems are ill suited for trading VIX and VIX products.
VIX tends to move opposite to the S&P 500 index and so when VIX is rising, equity prices tend to be falling and when VIX is falling, equity prices tend to be rising.
VIX averages around 20 over the long term, and in recent years has been in the teens for much of the time with occasional spikes higher during times of market stress.
VIX Futures Spend Most Of The Time In Contango
VIX futures contracts generally are in contango which means that farther out months are more expensive than closer in months or the spot price. The reverse of contango is known as “backwardation” which means that closer months are more expensive and this happens during times of intense market stress.
What this means to speculators is that the futures contracts will generally converge towards the cash price over time until expiration when they merge. So for a speculator to profit while contango is in effect, the price of futures contracts are steadily in decline and so the difference between the cash price and futures price must first be overcome before a profit can be realized.
VIX Is Mean Reverting
Another characteristic of the VIX Index is that it tends to be “mean reverting,” that is, it tends to return to an average level after extreme moves either up or down in direction.
This mean range tends to be in the 15-20 range in recent history and so this phenomenon also makes VIX trading potentially profitable for short term trading but potentially problematic for trend followers or long term investors.
The “fear” spikes tend to be very short term and severe but short lived as fear then drops and returns to its normal mean. VIX typically does not trend but rather spikes up and down around the median range.
These large spikes higher are usually followed by declines or reversion to mean and so investors and speculators in this arena need to have nimble trading programs to be able to take advantage of these rapid moves up and down.
To learn more about the VIX and how to trade the VIX, take a look at the links below:
Other VIX Resources:
–> VIX Central
–> VIX Contango