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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. To read our full disclosure, please go to: http://www.equities.com/disclaimer


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Results for VXX
Mark Sebastian
25 Apr 15 10:50:23
RT @CBOE: The Week in Volatility Indexes and ETPs – 4/20 – 4/24 http://t.co/9JbMZhRom4 @RussellRhoads looks at a long dated OTM $VXX put tr…
PolgarStocks
25 Apr 15 10:37:37
$F Percent Change Updated Saturday, April 25, 2015 1:07:02 PM $CELG $SUBK $VALE $VXX http://t.co/GtFwHv5oRH
James DiPlata
25 Apr 15 10:23:11
RT @OM_giveaways: Top 5 Stocks of 2015 Free HD Video!!!! $GOOGL $AAPL $TSLA $SSYS $VXX $VIX $SPY $SPX #stocks http://t.co/M2rcBOWo2Z http:/…
Russell Rhoads
25 Apr 15 10:07:38
RT @CBOE: The Week in Volatility Indexes and ETPs – 4/20 – 4/24 http://t.co/9JbMZhRom4 @RussellRhoads looks at a long dated OTM $VXX put tr…
Ijaz Ahmed
25 Apr 15 09:58:57
RT @CBOE: The Week in Volatility Indexes and ETPs – 4/20 – 4/24 http://t.co/9JbMZhRom4 @RussellRhoads looks at a long dated OTM $VXX put tr…
CBOE
25 Apr 15 09:53:52
The Week in Volatility Indexes and ETPs – 4/20 – 4/24 http://t.co/9JbMZhRom4 @RussellRhoads looks at a long dated OTM $VXX put trade
Stock Hobbit
25 Apr 15 09:31:06
Looking to follow professional stocks and options #traders? Try here http://t.co/ndv5bWOOj4 $VMW $QCOM $VXX $VIX http://t.co/JYlpnO2DTv
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25 Apr 15 09:29:20
RT ☐ Free guide to Pattern day trader status http://t.co/iCTm3fq35f $VIX $VXX $OEX http://t.co/iCTm3fq35f
Carolyn B Miciano
25 Apr 15 09:22:37
Free guide to Pattern day trader status http://t.co/zS1Zq0HtAQ $VIX $VXX $OEX
OM_giveaways
25 Apr 15 09:18:06
Top 5 Stocks of 2015 Free HD Video!!!! $GOOGL $AAPL $TSLA $SSYS $VXX $VIX $SPY $SPX #stocks http://t.co/M2rcBOWo2Z http://t.co/fBwqXHT6jS
Bradley
25 Apr 15 09:08:06
I love this trading girl! $XLF $FXI $BAC $KO $EEM $TLT $EWT $COP $QQQ $VXX $XOP http://t.co/l9JkTCtpHR http://t.co/AbnJJQ7VQY
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25 Apr 15 08:36:06
$NFLX Filings Updated Saturday, April 25, 2015 11:07:05 AM $IBB $VXX $MTL $SMH http://t.co/Y8TYvG9tOP
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$VLTC Percent Change Updated Saturday, April 25, 2015 11:07:05 AM $SLW $VXX $ITB $RSP http://t.co/B56XZIcxwt
selling_theta
25 Apr 15 08:11:15
@jmanfreddi spot can't go much lower; but without some real selling pressure it will be tough for futures to rise. Same for $VXX.
Carolyn B Miciano
25 Apr 15 07:50:57
Complete guide to adjustments to single Options positions http://t.co/kQpU3XdsnY $VIX $VXX $OEX
J.
25 Apr 15 07:14:06
RT @SwatOptions: $VXX 9k sweep may.08 call 21 AT 0.8$ - welcome to volatility again?
Carolyn B Miciano
25 Apr 15 06:35:06
Understanding VIX Futures and $VIX http://t.co/37JucIcwyO $VIX $VXX $OEX
PolgarStocks
25 Apr 15 06:34:39
$AGEN News Updated Saturday, April 25, 2015 09:07:05 AM $VXX $ABX $SBUX $CELG http://t.co/6Du7LakpaB
royfberger
25 Apr 15 06:11:11
Barcelona! Take me back! $XLF $FXI $BAC $KO $EEM $TLT $EWT $COP $QQQ $VXX $XOP http://t.co/JUFJoVvAWo http://t.co/MvTGrVa58f
Carolyn B Miciano
25 Apr 15 05:07:59
Master the Bull Put and Bear Call spreads http://t.co/4ZprJijtf7 $VIX $VXX $OEX
Stock Hobbit
25 Apr 15 04:54:08
Looking to follow professional stocks and options #traders? Try here http://t.co/ndv5bWOOj4 $VMW $QCOM $VXX $VIX http://t.co/hKPYvPk8Zb
OM_giveaways
25 Apr 15 04:38:05
Top 5 Stocks of 2015 Free HD Video!!!! $GOOGL $AAPL $TSLA $SSYS $VXX $VIX $SPY $SPX #stocks http://t.co/M2rcBOWo2Z http://t.co/m9Y9vXRrSI
Usama
25 Apr 15 03:22:45
@HFTAlert Thoughts on $VXX action from the past week?
Zero Filter
25 Apr 15 03:12:16
Anyone access data see #lunacy $AMZN St. '16/'17 EPS ests going violently all directions. One scariest things career $MSFT $VXX @jimcramer
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25 Apr 15 02:30:11
$VXX Short Sales Updated $MYEC $TSLA $XLK $GM http://t.co/Yh1Yk6nyIa
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25 Apr 15 02:28:40
$USO Stock Message Board Updated $VXX $GOOG $SQQQ $CYBR http://t.co/9fnib9WNbR
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25 Apr 15 01:59:01
Weekly ETF Gainers / Losers $URA $EWZ $BRF $ILF $QQQ $VXX $GAZ $EPI $UNG $SIVR http://t.co/wICoXeksbc
Stock Hobbit
25 Apr 15 01:40:07
Looking to follow professional stocks and options #traders? Try here http://t.co/ndv5bWOOj4 $VMW $QCOM $VXX $VIX http://t.co/iKal1q800X
Rosner Stocks
25 Apr 15 01:27:36
$VXX Stock Message Board Updated $KO $SLW $NUGT $INTC http://t.co/o35zxGuEc5
Northy
25 Apr 15 00:14:38
@WilliamK82 I prefer selling $VXX on spikes, but yes there are times when $VXX work nicely.
IH News Desk
24 Apr 15 23:46:04
$ABX Short Sales Updated $VXX $IGN $TBT $SMH http://t.co/ASdFbreHlN
OM_giveaways
24 Apr 15 23:22:10
Top 5 Stocks of 2015 Free HD Video!!!! $GOOGL $AAPL $TSLA $SSYS $VXX $VIX $SPY $SPX #stocks http://t.co/M2rcBOWo2Z http://t.co/xUNDeELfvM
Eternity101
24 Apr 15 22:55:40
... and i can't find $SPY in my Eternity stream/tweets i tweeted it awhile back. & can't be bothered right now. $VXX 52wk low $UVXY 52wk lo
PolgarStocks
24 Apr 15 22:25:38
$FB Reviews Updated Saturday, April 25, 2015 01:07:03 AM $INFN $SUBK $VXX $LNKD http://t.co/Da3z4a9ud0
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24 Apr 15 21:45:12
$COP Stock Price Updated Friday, April 24, 2015 12:11:06 PM $GOOG $VXX $SPXL $FXE http://t.co/JtYAf0z03n
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24 Apr 15 21:22:13
Our Stock Pick On $THCZ Is Up 481.54% From Our Initial Release! Major News: http://t.co/bLXWVUeOrx $LODE $VXX $RMKR
Stock Hobbit
24 Apr 15 21:11:07
Looking to follow professional stocks and options #traders? Try here http://t.co/ndv5bWOOj4 $VMW $QCOM $VXX $VIX http://t.co/ji741s4du7
Bradley
24 Apr 15 20:50:10
I love this trading girl! $XLF $FXI $BAC $KO $EEM $TLT $EWT $COP $QQQ $VXX $XOP http://t.co/l9JkTCtpHR http://t.co/TfIK6wHs4L
Stockaholics
24 Apr 15 20:46:47
We Have An Absolutely MASSIVE New Stock Pick Out! Get Early Access: http://t.co/P9qXvMc7W2 $LODE $VXX $RMKR
StockenheimerSchmidt
24 Apr 15 20:38:05
Platinum Members Saw Our Stock Alerts Gain Over 3100% In 6 Months! Subscribe Here: http://t.co/KjFX61Pd0S $LODE $VXX $RMKR
Langan Stocks
24 Apr 15 20:24:14
$VXX Financials Updated Friday, April 24, 2015 11:03:11 PM $PCLN $GOOG $JNPR $SMH http://t.co/89diVRsz9C
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24 Apr 15 20:10:29
Our Winning Penny Stock Picks Gained Over 3115% In The Past 6 Months! Huge News: http://t.co/Lau57a75up $LODE $VXX $RMKR
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24 Apr 15 19:49:59
Our Penny Stock Picks Gained 1472% In 2 Months! Get Access To Our New Pick: http://t.co/XxqN9MfSHf $LODE $VXX $RMKR
PolgarStocks
24 Apr 15 19:22:34
$GM Opinions Updated Friday, April 24, 2015 10:07:02 PM $VXX $QCOM $MCP $USO http://t.co/YpgBRF91ie
OM_giveaways
24 Apr 15 18:56:05
Top 5 Stocks of 2015 Free HD Video!!!! $GOOGL $AAPL $TSLA $SSYS $VXX $VIX $SPY $SPX #stocks http://t.co/M2rcBOWo2Z http://t.co/CaHq9szLYV
gordon gekko is god
24 Apr 15 18:55:24
Weekly ETF Gainers / Losers http://t.co/wPMOue4LZz $URA, $EWZ, $BRF, $ILF, $QQQ, $VXX, $GAZ, $EPI, $UNG, $SIVR
IH News Desk
24 Apr 15 18:42:37
$V Stock Forum Updated Friday, April 24, 2015 9:10:52 PM $RDSH $VXX $XLI $SWC http://t.co/vUCV37FmqY
PolgarStocks
24 Apr 15 18:22:09
$PG Company Info Updated Friday, April 24, 2015 9:07:01 PM $TQQQ $RXI $WFM $VXX http://t.co/ukQ4fIAnxz
Long-Term Investor
24 Apr 15 18:20:59
@NorthmanTrader Do you ever buy $VIX calls or $VXX when it gets low like this?
PolgarStocks
24 Apr 15 17:21:37
$VALE Investor Opinions Updated Friday, April 24, 2015 8:07:01 PM $VXX $SQQQ $TSLA $XLF http://t.co/p3hciXcIUU
				
				
By  +Follow October 14, 2013 8:46AM
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