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Understanding the VIX

By  +Follow October 14, 2013 8:46AM
Tickers Mentioned:

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."

Results for VXX
Stock Market News
20 Apr 14 02:58:13
$VXX Midday index, ETF option volumes http://t.co/2PhNXRWK6C
19 Apr 14 20:50:43
RT @etfguide: Buy the dips or buy the puts? (use promo 100APR to find out) http://t.co/cxursja8Zi $VXX $IVV $IJR $MDY $QQQ
19 Apr 14 17:35:42
RT @theflynews: $VXX iPath S&P 500 VIX Short-Term Futures are recently up 14c to 42.48: Full Story http://t.co/gfDKm7yRm2
Rhino's Glory Hole
19 Apr 14 17:01:47
POLL: Are You Bullish or Bearish on the Markets? @the_real_fly http://t.co/4B2DEgykwS $SPY $QQQ $DIA $GLD $VXX
19 Apr 14 15:17:20
Detailed look at vol $vxx “@quantivity: Path-Dependent Volatility: http://t.co/m7pKLSbzOI”
Jake Catskill
19 Apr 14 12:17:33
Vow to push forward on Ukraine pact meets defiance on the ground http://t.co/EJuDYFQ9YL [expect more volatility $RSX $VXX ]
Karl Rosoff
19 Apr 14 10:15:03
$VXX The Bears Gore The VIX Again – Weekly VIX ETF Report http://t.co/i3w67xtO1X
Derald Muniz
19 Apr 14 07:29:57
there is no $VXX weekend short trade
Karl Rosoff
19 Apr 14 00:18:03
$VXX Exchange-Traded Notes: Not the New Black http://t.co/ioAvLq8OIT
Rob Smith
18 Apr 14 17:49:32
@dcolella15 You have your $VXX trader, Now I have Mine!!! I'm hiring this guy!!! #YARRGH http://t.co/iJIOG30icQ
Kim Klaiman
18 Apr 14 16:38:19
RT @CBOE: This Week in Volatility Indexes and ETPs – 4/18/2014 http://t.co/CpD4brvtiJ $VXST $VIX $VXX $XIV
Russell Rhoads
18 Apr 14 14:15:46
RT @CBOE: This Week in Volatility Indexes and ETPs – 4/18/2014 http://t.co/CpD4brvtiJ $VXST $VIX $VXX $XIV
18 Apr 14 14:11:16
RT @CBOE: This Week in Volatility Indexes and ETPs – 4/18/2014 http://t.co/CpD4brvtiJ $VXST $VIX $VXX $XIV
18 Apr 14 14:10:09
This Week in Volatility Indexes and ETPs – 4/18/2014 http://t.co/CpD4brvtiJ $VXST $VIX $VXX $XIV
Karl Rosoff
18 Apr 14 13:31:05
$VXX Exchange-Traded Notes: Not the New Black http://t.co/hWlcHCjXNv
Karl Rosoff
18 Apr 14 13:25:04
$VXX Exchange-Traded Notes: Not the New Black http://t.co/GSRu76segz
18 Apr 14 09:35:26
$GLD On Watch $MU $WYNN $VXX $CHIQ $PGJ http://t.co/s7bv6WeBHf
18 Apr 14 09:10:35
$VXX Headlines Is this the correction, or a coming crash? 12:06 p.m. March 27, 2014 - The Trading Deck In focu http://t.co/qBNJLPaKmH
18 Apr 14 08:18:36
$VXX High Date=Apr-17-2014 Open=42.49 High=42.72 Low=41.62 Close=41.71 Volume=31577800 http://t.co/piHKHyvPcI
18 Apr 14 08:08:55
$YGE Buy? Click here to find out if $YGE is a buy hold or sell. Watching these stocks. $QASP $NOV $VXX $HESG h http://t.co/UWmikoAQ5N
18 Apr 14 07:27:17
Buy the dips or buy the puts? (use promo 100APR to find out) http://t.co/cxursja8Zi $VXX $IVV $IJR $MDY $QQQ
Volatility Indexes
18 Apr 14 07:14:29
$VXX: 41.71 ▆▆▃▁▁▁▂▅▂▁▆▇▇▆▃▂
18 Apr 14 06:38:10
1YR $SPY vs. $VXX. Showing average true range, MACD, & volume. http://t.co/2CGppblAOv
Jonathan Delehanty
18 Apr 14 06:03:26
@SAlphaTrending Where the mother is my Wall Street B-FAST!!! Oh, wait it's Good Friday! :( $SPY $DIA $QQQ $VXX Happy Friday!
18 Apr 14 04:48:12
Vxx looks poised for @ least ~ 2.5 pt. move up soon $VXX $VIX $TVIX $TVIX $UVXY $VIX $TNA $TZA $FAZ $FAS $SPY #vix #vxx
17 Apr 14 22:55:09
VXX 41.71 Stock Charts $VXX Barclays Bank PLC iPath S&P 500 VIX Short-Term Futures ETN (NAR) VXX Stock Chart - http://t.co/YyhlnA1vT2
gordon gekko is god
17 Apr 14 19:48:47
Weekly ETF Gainers / Losers http://t.co/YI2qe13yK3 $FCG, $XLE, $VDE, $XLI, $EWJ, $VXX, $GDXJ, $VNM, $GDX, $PHYS
Roy Harris
17 Apr 14 17:40:47
I bought $VXX long@41.74...put 40% of cash capital. .so that's 20% of portfolio on my margin account. .watching technicals and seeing that..
17 Apr 14 17:27:22
$VXX My order of 9 May w 39-40 short put spread executed at $0.39. I also have a short 2 May w 40-41 put spread. This will stay above $40.
17 Apr 14 14:52:45
The most manipulated ETF on the market is $VXX ( VIX) http://t.co/CfDHldfuZ4 **Hmmm.....
17 Apr 14 14:45:59
Weekly ETF Gainers / Losers http://t.co/StjPJBm33L $FCG, $XLE, $VDE, $XLI, $EWJ, $VXX, $GDXJ, $VNM, $GDX, $PHYS
17 Apr 14 13:16:48
When the tide is low ($SPY goes down) you get to see whose swimming naked. (the stocks that have the most leveraged weak players) $VXX $SDS
17 Apr 14 13:16:48
When the tide is low ($SPY goes down) you get to see whose swimming naked. (the stocks that have the most leveraged weak players) $VXX $SDS
Alexander Morris
17 Apr 14 13:15:18
$VXX: 1mHugeRngBar- [x4], ch:-1.6%, PDayGp-, tf:47, LowFlt[22.1M], AvgDyV/R=67.01M/1.77; 231x:758xTrdVol; TLM:4.2; ILM:1.8; DayRng=1.10
Pulsar Investments
17 Apr 14 12:49:39
As $VIX dives towards 12 level, we just sold $VXX puts >150% profit, and loaded a few more calls w/ May expiration. Volatility won't die~
17 Apr 14 12:48:01
BTO $VXX MAY 43 C 1.79 and Bought $UVXY 58.25 small
17 Apr 14 12:32:04
long $VXX next week $42.50 puts at .63 just in case....
17 Apr 14 11:05:13
Don't find fault, find a remedy. - Henry Ford $QQQ $VXX $TLT
17 Apr 14 10:59:17
$VIX 2.45 under May. multiple large declines will only get $VXX higher next week.
17 Apr 14 10:55:28
$VXX $vix looks tempting to go long here.
17 Apr 14 10:15:33
$vxx is being stubborn. Hope for rug pull by end of day
Market Int Center
17 Apr 14 10:11:28
Ipath VIX Short-Term Futures ETN $VXX Showing Resistance Near $44.21 ( http://t.co/XkmKpr0Go6 )
Karl Rosoff
17 Apr 14 10:01:05
$VXX Midday index, ETF option volumes http://t.co/KREYMbJCOS
17 Apr 14 09:52:48
$UVXY still has the potential to be shredded evn more between now and the close IMO. $VXX
17 Apr 14 09:50:01
$vxx being accumulated by algos..$qqq and $aapl being sold into this move higher
ETF Database
17 Apr 14 09:46:00
Trying to "Beat the Market" eh? Consider the Alternative #ETFs -> http://t.co/25m8iBJs06 --> #Volatility #Options #HedgeFund #VIX $XIV $VXX
Carlos Carrasco
17 Apr 14 09:41:45
Ukraine tensions about to de-escalate permanently. Watch your shorts and zip carefully. $vxx to be crushed.$qqq
17 Apr 14 09:23:23
$VXX : so far long 1K @ 41.95
17 Apr 14 09:02:03
chartguy89: Stock Charts: EWY Stock Chart $EWY $ZNGA $HZNP $VXX http:// http://t.co/LXM0l2rhlR
17 Apr 14 09:01:58
DennyT: The Hunt for the Next 10 Bagger: VXX Basic Tech. Analysis $VXX $FXI $TFER $MINE $XL http://t.co/q7N9NOBUol
By  +Follow October 14, 2013 8:46AM



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