The CBOE VIX, also known as the volatility index, shows the expected market volatility based on the option prices of the S&P 500 index. It is called the “fear gauge” as it reflects investor sentiment: It rises when there is uncertainty and falls when there is confidence.
VIX in a nutshell
- The CBOE VIX, the volatility index, measures market volatility based on the prices of S&P 500 options.
- The VIX, which is often referred to as the “fear gauge”, rises with uncertainty and falls with confidence.
- Traders use VIX-linked products for diversification, hedging and speculation to manage market risk.
- The VIX can be traded with futures, options, ETFs and ETNs.
What does the VIX measure?
The CBOE Volatility Index (VIX) is a real-time measure of market volatility developed by the Chicago Board Options Exchange (CBOE). It serves as a standard metric for assessing market volatility and is particularly crucial for traders and investors. The VIX provides valuable insight into market risk and investor sentiment by anticipating the volatility of the S&P 500 (SPX) over the next 30 days.
There is a correlation between a high VIX and a high degree of fear and unpredictability in the market. That is why the VIX is also called the “Fear Index”.
What are the different VIX levels?
The VIX serves as a barometer, indicating five levels of turbulence within the stock market. The VIX can be divided into the following five levels:
- Low VIX (0-15): Optimism in the market, which promises investors a smooth process.
- Moderate VIX (15-20): Normal market conditions in which risks and opportunities are balanced.
- Increasing VIX (20-25): Increasing concern among traders and investors.
- High VIX (25-30): Serious turbulence with volatile and unpredictable market movements.
- Extremely High VIX (30+): Extreme turbulence, signalling a stormy time for the market.
How can the VIX index be used for diversification and hedging?
The substantial negative connection between VIX-linked products and the stock market has gained enormous popularity as an alternative for diversifying and hedging and plain speculation amongst professional investors. With a stake in the VIX, you may be able to level out your other stock investments and protect against market risk.
For instance, imagine you hold a long position in the S&P 500-listed US firm stock. Despite your belief in its long-term potential, you’d want to limit your exposure to any potential volatility in the stock price in the near term. Because you believe volatility will rise, you establish a trade to purchase the VIX index. If you do this, you may achieve a sense of equilibrium between the two sides.
Because of this, you may be able to offset some of your losses from your VIX strategy with profits from your current trade.
How can a trader or investor trade in VIX?
The VIX cannot be purchased directly like other indices. However, there are some common methods for trading the VIX:
- VIX Futures: Investors can use these contracts to speculate on the future volatility of the market. Traders can buy (long) or sell (short) VIX futures depending on their market outlook.
- VIX Options: VIX options give the right to buy or sell VIX futures at a certain price within a certain time frame. Options can be used for hedging or speculative purposes.
- Exchange-Traded Funds (ETFs): Multiple ETFs track the VIX and allow investors to participate in volatility without trading futures or options directly. These ETFs can be bought and sold like stocks, providing convenience and liquidity.
- Exchange-Traded Notes (ETNs): Similar to ETFs, ETNs offer exposure to the VIX through debt securities. The value of ETNs is linked to the performance of the underlying index and offers another way to trade volatility.
The ProShares VIX Short-Term Futures ETF (VIXY), which tracks VIX futures contracts with a 30-day maturity, is a very popular and easy-to-access option.
The Cboe S&P 500 three-month (VIX3M) and the Cboe S&P 500 six-month (VIX6M) are instances of brief volatility indexes that represent the S&P 500 Index’s predicted volatility over the next six months (VIX6M).
For example, if a stock has a rise of +1.5, it is potentially 50% more unstable than the market. Traders use elevated stock options to properly get the VIX volatility estimates to price their options deals accurately.
Can You Trade the VIX with Binary Options?
No binary options broker currently offers binary options trading for the CBOE VIX (volatility index). While the VIX is a popular measure of market volatility, binary options generally focus on other assets such as currencies, stocks or commodities.
Whether novices or seasoned pros, investors should exercise caution before committing significant sums of money to the market. Before making any major decisions, looking at the VIX market index over the last 2–3 months is a good idea.