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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
Carolyn B Miciano
21 Oct 14 11:14:07
Guide to Option Spreads http://t.co/K3CmFY9Ft9 $VIX $VXX $OEX
biostock
21 Oct 14 11:13:48
$VXX Beware this will reset lower after hours.will visit 29.47 in next 2 days $VIX close of $16.05 and lower lows ahead $SPX next tgt 1955
Link Plugged
21 Oct 14 11:11:38
@smbcapital: When to trade ETFs? $STUDY > http://t.co/LZgziQvBM6 $SPY $IWM $VXX $FAS http://t.co/9dzz0aIG0v
SMB Capital
21 Oct 14 11:06:32
When to trade ETFs? $STUDY http://t.co/Q0CHnxYhBO $SPY $IWM $VXX $FAS
MJR
21 Oct 14 10:56:49
$NQ_F Adding another position to $QQQ swing short here at 96.51.However,im looking to take loss on $TZA $SPY , $VXX by bell. Lower,hopefully
steven spencer
21 Oct 14 10:17:42
the lack of volatility in this market is getting kind of depressing. $VXX
Mark Mansfield
21 Oct 14 08:14:57
@ETFSwingTrader Bought $QID yesterday afternoon $VXX about 30min ago. Pain so far. Sold $XIV yesterday, clearly early.
Jeff
21 Oct 14 08:06:23
@BillTsamis @twitter @BloombergTV @mattmiller1973 $VXX $VXYZ search tags work. Can anyone post a $TVIX tag that pulls up in search?
Jeff
21 Oct 14 07:56:39
Anyone in #volatility plays $UVXY $VXX $VXZ $VIX notice the TVIX feed is frozen on @twitter ???? @BloombergTV you guys see this also?
Eli Mintz
21 Oct 14 07:48:41
@EconomPic The values of $VXX $UVXY $ZIV etc. are directly related to the contango in the $VIX futures, not the indices.
Thu Real Matt
21 Oct 14 07:40:25
The contango king is back $VXX $UVXY $VIX $VX_F
Æther Analytics
21 Oct 14 07:31:08
$VXX dirt nap
jake
21 Oct 14 07:05:30
sold $VXX puts +75%
Nader
21 Oct 14 06:37:10
Just sold my Nov $35 $VXX puts for 102% profit...thanks @CAMAR024 for that great play
Kora Reddy
21 Oct 14 06:35:50
order of the day is a small red candle on $SPY , do nothing ? or poke into $VXX calls ??
jake
21 Oct 14 06:34:43
gonna take profits on $VXX puts today I bought last week, wanna see if i can get a flush under 34
steven spencer
21 Oct 14 05:33:59
Expanding Volatility (video) http://t.co/AeTRiI1RSX $SPY $VXX $STUDY #tradingtips
Jeff
21 Oct 14 05:15:56
$UVXY $TVIX $VXX #VIX #Volatility Still short TVIX http://t.co/ouucVYxx1Q
Bill Tsamis
21 Oct 14 03:59:20
GM :) as $VXX gets closer to my target of $33s, opened starter pos in $UVXY $32.60
Stock Forums
21 Oct 14 03:52:55
$EWL P/E Ratio Click Here: http://t.co/h1npwF2RaU Also See: $VXX $INCC $GLD $BABA ~
Binary System
21 Oct 14 03:15:10
RT @tymorapro: $VXX: GapDN 0.73[-2.1%,fill:53%], PrvCl:35.60, PrvLo:35.54, 1NewLo, 9:6Accel-, tf:1000000, MedFlt[35.3M], p$vol:2.53M; TrdVo…
Chasing Stars
21 Oct 14 03:09:27
$EWH Filings Click Here: http://t.co/dXUHzDVcSq Also See: $BAC $EWP $VXX $EDN ~
Alexander Morris
21 Oct 14 03:08:33
$VXX: GapDN 0.73[-2.1%,fill:53%], PrvCl:35.60, PrvLo:35.54, 1NewLo, 9:6Accel-, tf:1000000, MedFlt[35.3M], p$vol:2.53M; TrdVol:6x:4945x
Carolyn B Miciano
21 Oct 14 02:07:37
Free course on #stocks and Options differences http://t.co/ubfOO4Fvfh $VIX $VXX $OEX
VolatilityIndexes
21 Oct 14 01:29:32
RT @TomLydon: For Downside Hedging, This is the Right #ETF http://t.co/zkvJo5r4uH #ETFs #vix #sp500 #volatility $VXX $PHDG
Stock Forums
21 Oct 14 01:20:39
$EBAY 52Wk High Click Here: http://t.co/8KHOKQpxAu Also See: $GOOGL $VXX $ISIS $MCP ~
Rosner Stocks
21 Oct 14 01:14:23
$DRYS Current Price Click Here: http://t.co/Sr0I6HKx2m Also See: $LQD $VXX $TMF $IBM ~
Stockaholics
21 Oct 14 00:27:56
Our Penny Stock Picks Gained 371% In 2 Weeks! Get Our Next Pick Early: http://t.co/z2noBUWrEP $LODE $VXX $RMKR
David Hegedus
20 Oct 14 23:48:09
In market storm, a rush to trade volatility itself $VXX $UVXY http://t.co/4P3cYMC5wX via @YahooFinance
Investors Hangout
20 Oct 14 22:00:38
$CAT E.P.S. Click Here: http://t.co/SfhyBceSpS Also See: $MCP $VZ $EDN $VXX ~
blogstocks
20 Oct 14 21:33:52
Expanding Volatility– $SPY $VXX: Options Risk Disclaimer Forex Risk Disclaimer 1. SMB… http://t.co/pJYdEagIcf
Investmentclique
20 Oct 14 21:02:14
Expanding Volatility– $SPY $VXX: I share some thoughts on trading adjustments we make in a mark... http://t.co/aXkIsISnae #trade #stocks
BowerPost
20 Oct 14 21:01:54
Expanding Volatility– $SPY $VXX - I share some thoughts on trading adjustments we make in a market with expanding ... http://t.co/EcngHyrsJw
Guy Bower
20 Oct 14 21:01:53
Expanding Volatility– $SPY $VXX - I share some thoughts on trading adjustments we make in a market with expanding ... http://t.co/zuN3nTLyV6
Ron DeLegge
20 Oct 14 20:27:20
RT @etfguide: If you're not yet subscribed to @etfguide's YouTube channel, here's what you've been missing: http://t.co/FU7Vuk3C1v $IVV $E…
PortfolioWorkstation
20 Oct 14 20:14:58
RT @OMillionaires: $VIX high last week of 31.06 was highest since 11-28-2011. A 30 read implies 1.89% intra-day/8.66% monthly moves on S&P…
steven spencer
20 Oct 14 20:11:45
Expanding Volatility (video) http://t.co/p0LYClR5It $SPY $VXX $Study #tradingtips
Eyang Sukur
20 Oct 14 19:17:32
RT Chayton Falke ChaytonFalke : Recent #Trading #Top #Gainer #8 - SOLD $VXX for a 31.11% gain! LONG only 8 days! #VXX #forex #stocks
Chayton Falke
20 Oct 14 19:15:05
Recent #Trading #Top #Gainer #8 - SOLD $VXX for a 31.11% gain! LONG only 8 days! #VXX #forex #stocks
Jeff
20 Oct 14 19:12:52
#Volatility #VIX - Shorting vehicle $TVIX gives greater leverage than $VXX $VXZ $VIXM plus faster decay http://t.co/is0UHuyIms
HCPG
20 Oct 14 18:37:53
RT @ZorTrades: Don’t Short In The Hole, Try Now ZorTrades http://t.co/e36cpziA6l $SPY $VIX $VXX
Andrew Rocco
20 Oct 14 18:11:55
RT @ZorTrades: Don’t Short In The Hole, Try Now ZorTrades http://t.co/e36cpziA6l $SPY $VIX $VXX
Frank Zorrilla
20 Oct 14 18:04:03
Don’t Short In The Hole, Try Now ZorTrades http://t.co/e36cpziA6l $SPY $VIX $VXX
ETF Godfather
20 Oct 14 17:23:25
RT @ETFtrends: For Downside Hedging, This is the Right #ETF http://t.co/qAFMpHOnId #ETFs #vix #sp500 #volatility $VXX $PHDG
Carolyn B Miciano
20 Oct 14 17:18:37
Take Iron condors to the next level http://t.co/4m0kR1b4v1 $VIX $VXX $OEX
ETFguide.com
20 Oct 14 16:51:14
If you're not yet subscribed to @etfguide's YouTube channel, here's what you've been missing: http://t.co/FU7Vuk3C1v $IVV $EFA $VXX $IWM
Joshua Sanchez
20 Oct 14 16:50:39
$VXX Got ya face ripped off a little didn't ya?
Navi Avatar
20 Oct 14 16:08:31
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Carolyn B Miciano
20 Oct 14 16:00:22
How to buy Put options for a bearish move http://t.co/UKRjNnnBQA $VIX $VXX $OEX
Gary Compton
20 Oct 14 15:55:32
RT @michaelsantoli: In the 5-day market storm, $100 billion was bet on a mere statistic. New post on the surge in VIX trading. http://t.co…
				
				
By  +Follow October 14, 2013 8:46AM
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