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Understanding the VIX

By  +Follow October 14, 2013 8:46AM
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Traders have long been able to find ways to create mathematical formulas to track certain types of market movement so that they can then place bets on them. Between the hundreds of different indices and ETFs out there, if you have a prediction about just about anything that might happen throughout the global economy, there’s a way to profit (or NOT profit) from your inkling.

And one of the most popular things they’ve ever created was the formula that’s now used for the Chicago Board Options Exchange Market Volatility Index (VIX). It uses options trades as a barometer for how volatile traders expect the market to be over the next month. Since it was introduced in January of 1993, the index has captured the interest of traders and investors alike, with the S&P 500 VIX Short-Term Futures ETN (VXX) coming in as the third most popular ETF, with average volume of almost 45 million shares.

But what does the VIX really mean? It’s known as the “fear index,” and generally believed to reflect panic in the markets. But is that what it’s really supposed to mean?

Calculating Volatility

Given its popularity, it should be important to note what, exactly, the VIX is supposed to track. It’s not a measure of present volatility. Nor is it technically a prediction of future volatility, though one could choose to read it as such. Rather, the VIX is a measure of current market sentiment regarding future volatility. Basically, what are today’s traders doing while they try to predict what’s going to happen over the next 30 days? When traders appear to be anticipating big moves in the market in the next 30-days, it should mean the VIX goes up. If they appear to be betting on smaller market moves, it goes down.

The benchmark that’s used to measure that current market sentiment is options trading. The method was developed by Prof. Menachem Brenner and Prof. Dan Galai in 1986 and then published in the July/August 1989 issue of Financial Analysts Journal. Without going to deep into options, they’re essentially contracts to either buy or sell stock at a certain price at a future date. Basically a way to bet on whether or not a stock will go up or down without actually buying the stock. The VIX tracks what options are being bought and sold, and how big the strike price on those options are. A larger strike price implies that the person buying the option forsees a bigger move in that stock’s price. So, if options are being written with larger strike prices, it probably means the market is anticipating bigger swings over the length of those options.

The Fear Index?

So, it should be noted that the index is not intended to be predictive. It’s measuring the current market sentiment about the next 30 days. Traders seem to believe that the S&P is going to make a big move, but that doesn’t mean that they’re right. In fact the correlation

It should also be noted that the index doesn’t indicate whether the anticipated movement is up or down. A large volume of traders buying call options with high strike prices would indicate they’re predicting a bull market, and it would also push up the VIX.

And this is important, because the perception of the VIX as the “fear index” appears to be inaccurate. It's not an indication that a major sell-off is forthcoming. In fact, it could mean just the opposite. The only thing a high VIX should mean is that people buying options are anticipating a lot of movement in the market over the next month. It doesn't really mean anything else.

Or does it?

A Self-fulfilling Prophecy

Perception can mean everything. And the idea that the VIX is the “fear index” is a powerful one. A sharp rise in the VIX is enough to make some traders sell off equities and shift into a risk-off environment. And, of course, if an increasing VIX results in people selling equities, it means it can result in the equities market falling anyway.

So whether or not traders really understand what the VIX means, the fact that they believe it’s the “fear index” makes it the “fear index” on some level. Which can mean that, despite what the VIX actually measures and should represent, the effect it has on the market ends up being that of a "fear index."

A Volatile Way to Trade

Ironically, what makes the VIX such a popular trading vehicle through its ETF is that it's so volatile. So the index tracking volatility is volatile. Go figure. The volume of shares trading hands on the major VIX ETFs proves that traders are interested in continuing to follow the "fear index."

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.


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Results for VXX
OTPicks.com
22 Sep 14 14:12:24
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Kevin B. Bantz
22 Sep 14 13:45:27
Commented on StockTwits: YOU'RE WELCOME @charttrade $tvix $uvxy $VXX $VIX $CVOL http://t.co/vnfSpS3vya http://t.co/c8faSVN7Ko
Top ETF Funds
22 Sep 14 13:33:22
Midday index, ETF option volumes.. http://t.co/slNVznfHhw $VXX #ETF #ETFs #Stocks
Top ETF Funds
22 Sep 14 13:33:06
Analyzing Treasury yields ahead of the Fed’s September 2014 FOMC.. http://t.co/Ebr86dBvPA $VXX #ETF #ETFs #Stocks
Eli Mintz
22 Sep 14 13:31:08
$VIX futures contango settled at 3.69% It has become much cheaper to hold $VXX and $UVXY long term
Play
22 Sep 14 13:29:25
$VXX http://t.co/szpJE0r01r
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22 Sep 14 13:28:56
$VXX Giddy up... Waiting for 27.75
Stock Blender
22 Sep 14 13:23:15
$VXX big volume! Confirmation we will see.
TV_Trading Ideas
22 Sep 14 13:19:37
$VXX looking to finish testing what it just gained forming C&H $VXX http://t.co/OGtabufH7U
Play
22 Sep 14 13:19:37
$VXX chart: $VXX looking to finish testing what it just gained forming C&H. http://t.co/MJnBeTllmb
selling_theta
22 Sep 14 13:17:30
decent pop in October $VIX after the bell. that's why $VXX spiked, too.
Jamie Lissette
22 Sep 14 13:14:38
look at that VXX after hours $vxx
Jon Vince
22 Sep 14 13:12:55
$VXX picking up MoMo in a/h. Up 1%, .28 since close -$28.46
Alexander Morris
22 Sep 14 13:10:03
$VXX: 1mRunaway+:1 [+4%,.2%offHi], FltBO-, PDayGp-, 4:2Accel+, tf:3f; TrdVol:52x:25287x; TLM:4.8; ILM:1.9, PrvClGap+[+1.2%,fill:72%]
Carolyn B Miciano
22 Sep 14 13:08:57
Risk graphs are critical in Options http://t.co/e9UDURwuRx $VIX $VXX $OEX
MRMARKETTE
22 Sep 14 12:51:13
Isn't slamming the $VXX in the last 15min getting old? We get it you're propping up the indices.
BlockTradeAlert
22 Sep 14 12:38:35
BLOCK TRADE: $VXX 546,000 shares @ $28.25 [15:38:34]
lizwaite
22 Sep 14 12:37:31
RT @WalterLiveOak: $vxx long from 33.00 it's a hedge
Walter Live Oak
22 Sep 14 12:24:15
$vxx long from 33.00 it's a hedge
Stock Blender
22 Sep 14 12:20:32
$VXX up on above average vvolume interesting. Caution on Turn around Tuesday?
SpoonFedStocks
22 Sep 14 12:20:06
RT @tradevolatility: Our $VXX Bias indicator turned positive Thursday to signal a VXX uptrend. Next signal in 90 minutes. http://t.co/Sp8MX…
Trading Volatility
22 Sep 14 11:59:49
Our $VXX Bias indicator turned positive Thursday to signal a VXX uptrend. Next signal in 90 minutes. http://t.co/Sp8MXMdIIP
Craig Garbers
22 Sep 14 11:50:25
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Sentimentcharts
22 Sep 14 11:36:23
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Blair Jensen
22 Sep 14 11:34:22
Actively managed shorts and mid term volatility rising. Signs of hedging. $HDGE $VXZ $VXX $SH http://t.co/iDS9BYl0B9
Jean Fonteneau
22 Sep 14 11:31:56
$VXX we started to add last week on Fed day starting to look pretty good, $VIX could give us more action this week but expect to sell at EOW
Carolyn B Miciano
22 Sep 14 10:59:00
Become a chart reading expert http://t.co/eFT4rMTLIb $VIX $VXX $OEX
Iskounta
22 Sep 14 10:56:12
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22 Sep 14 10:54:51
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Investors Hangout
22 Sep 14 10:54:48
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DennyT
22 Sep 14 10:45:02
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22 Sep 14 10:38:06
$JNK Parabolic SAR $JNK Most recent stock chart and technical analysis. $AVGO $NUGT $VXX $EFA $CMG $GLD http:/ http://t.co/CSoKjvZQnf
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22 Sep 14 10:18:06
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Zero Filter
22 Sep 14 10:06:06
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TalkMarkets
22 Sep 14 09:47:56
Long-Term Uptrend Remains Intact – Weekly Market Outlook $SPX $VIX $VXX $COMP #stocks http://t.co/wF7Ghu9j16
Keystone Speculator
22 Sep 14 09:47:06
$VIX #chart shows #volatility above 200-day MA ushering in #market weakness. $VXX $XIV $SPX $SH $SDS #WallStreet #etf http://t.co/4VmjNexqcp
Shawn
22 Sep 14 09:47:02
@e_dawg8 May hold for more than 5 pts if we see a strong move off the lower T/L of the wedge. $VXX building a shooting star on the hourly
Dumb Money
22 Sep 14 09:46:02
@lalaruza74 $DUST and $NUGT about 10 months. $VXX, $DRV, $TECS, $ERY about 4-5 years
Investors Hangout
22 Sep 14 09:06:44
danrocks: $INCC Buzz $VXX $PANW $FXE $GOOG $OTIV http://t.co/IbGdSTiiBo
Investors Hangout
22 Sep 14 09:06:30
danrocks: $INCC Buzz $VXX $PANW $FXE $GOOG $OTIV http://t.co/2cQJ8dippb
danrocks
22 Sep 14 08:50:18
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Eternity101
22 Sep 14 08:37:55
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Keybot the Quant
22 Sep 14 08:37:23
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Investors Hangout
22 Sep 14 08:36:24
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22 Sep 14 08:36:11
danrocks: $VXX Picking Up MOMO $DDD $XLY $TIP $DIS $RSX http://t.co/JGnQLHswoP
danrocks
22 Sep 14 08:30:11
$VXX Picking Up MOMO $DDD $XLY $TIP $DIS $RSX http://t.co/U8EAbBvZfl
leahanne
22 Sep 14 08:08:03
$PBR Petroleo Brasileiro S.A.- Petrobras (PBR) 15.93 -0.85 (-5.07%) $VXX $CPE $XIV http://t.co/nXcL2CEDw5
danrocks
22 Sep 14 08:04:47
$KWK alot of talk going around about this one $VXX $SDRL $NUGT $FXI $EDZ http://t.co/JMn1su6hbz
Carn
22 Sep 14 08:02:41
October $SPX Puts and $VXX calls springing to life this morning. Think the 2014 high is in.
				
				
By  +Follow October 14, 2013 8:46AM
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