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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
Anmol Singh
21 Nov 14 18:41:26
Made today's Video Newsletter free so you can get a taste $STUDY $TLT $BTU $VZ $VXX $SPY $XLE $FB $TRUE $EWJ $GLD http://t.co/xCRB7hm573
Anmol Singh
21 Nov 14 18:40:06
Made today's Video Newsletter free so you can get a taste $STUDY $TLT $BTU $VZ $VXX $SPY $XLE $FB $KATE $TRUE $EWJ $GLDhttp://goo.gl/oDsRt7
Stockaholics
21 Nov 14 17:24:43
578% Gains On Penny Stocks in one month! Plus a New Pick Is Coming: http://t.co/2W3yKD2d5Q $LODE $VXX $RMKR
Richard Gobel
21 Nov 14 14:17:40
KirkSpano : I like the look of the stair-step higher in the $VXX that my algo number is displayin... http://t.co/BJSNouA2vM via Scutify
Jean Fonteneau
21 Nov 14 14:13:59
@CNBC FMHR "traders" really really nice this week: Long $GPRO in front of 2ndary, long $VXX - GoPro headed to $90? http://t.co/yG2tiXk7co
brian stu
21 Nov 14 13:38:03
RT @VixCentral: $VIX futures contango settled at 7.36% It is expensive to hold $VXX and $UVXY long term. If current trends continue, contan…
ARENA BURSATIL
21 Nov 14 13:36:51
publicando nuestro analisis tecnico semanal con cubrimiento a: $SPX $TSX $IGBC $Oil $VXX http://t.co/mxePcSDbrN
Rich
21 Nov 14 13:31:18
RT @VixCentral: $VIX futures contango settled at 7.36% It is expensive to hold $VXX and $UVXY long term. If current trends continue, contan…
Eli Mintz
21 Nov 14 13:28:15
$VIX futures contango settled at 7.36% It is expensive to hold $VXX and $UVXY long term. If current trends continue, contango>10% is likely
WallStreetStar
21 Nov 14 13:15:24
Nice day for Brazil stocks, $EWZ up almost 7%. Next week I am short $AAPL and $QQQ. Long $USO $VXX. I may get long $TWTR as well.
Helyn Bolanis
21 Nov 14 13:00:50
#timestamp Sold $VXX for PAMS 2 at $27.62
TRADING THE ODDS
21 Nov 14 12:51:40
Trading Volatility (#VRPStrategy) on Fri., 11/21/2014 : Long $XIV closed, switch to $VXX (market-on-close). http://t.co/VaqWnlQjDj
wsmco
21 Nov 14 12:51:27
Sold to open $VXX Dec 5 27 puts at .57
Agent Blowfish
21 Nov 14 12:28:25
Sold last third of $XIV at 38. Around 3% profit. All out of XIV now. $VIX $VXX
TV_Trading Ideas
21 Nov 14 12:25:02
$SDS $VXX $IWM I will ask you again! $SPY http://t.co/fn1IzKLoEb
Iskounta
21 Nov 14 12:25:02
$SPY chart: $SDS $VXX $IWM I will ask you again!. http://t.co/6XIGeCMMyH
Main Street Alpha
21 Nov 14 12:23:25
Moving the $VXX Nov28 $28C entry to .44 from .48
Zero Filter
21 Nov 14 12:13:05
#Bearish market call (new mkt highs flagging participation) #CNBC #CantorFitzgerald - Noteworthy given parade bulls all day long $SPY $VXX
Investors Hangout
21 Nov 14 12:12:08
lookn4wins: VXX 27.88 Stock Charts $VXX Barclays Bank PLC http://t.co/n7xnyb55tG
Investors Hangout
21 Nov 14 12:12:05
lookn4wins: VXX 27.88 Stock Charts $VXX Barclays Bank PLC http://t.co/0iq9MgHwCX
iHangout
21 Nov 14 12:08:41
http://t.co/vVojvWiBbX lookn4wins: Stock DD Board: VXX 27.88 Stock Charts $VXX Barclays Bank PLC http://t.co/6gkRFXaWSU
lookn4wins
21 Nov 14 12:04:23
VXX 27.88 Stock Charts $VXX Barclays Bank PLC iPath S&P 500 VIX Short-Term Futures ETN (NAR) Any opinions on V http://t.co/lNbpJrM8U1
Jack Damn
21 Nov 14 12:02:20
MarketSci’s Mean-Reversion $VIX Trading Strategy http://t.co/zr6bM6jtCN System analysis by VMS. $VXX $XIV http://t.co/hPjVqKzTon
TV_Trading Ideas
21 Nov 14 11:58:44
$SDS $IWM $VXX All day they are selling to you! $SPY http://t.co/bGU5AbuNkY
Iskounta
21 Nov 14 11:58:44
$SPY chart: $SDS $IWM $VXX All day they are selling to you!. http://t.co/W1R9QrzrnI
TV_Trading Ideas
21 Nov 14 11:54:09
$IWM $SDS $VXX This hurts! $SPY http://t.co/6T39QSO1wE
Iskounta
21 Nov 14 11:54:09
$SPY chart: $IWM $SDS $VXX This hurts! . http://t.co/GpmcV3Vfna
TRADING THE ODDS
21 Nov 14 11:51:26
Trading Volatility (#VRPStrategy) on Fri., 11/21/2014 (preliminary estimate): Long $XIV closed, switch to $VXX (market-on-close).
TV_Trading Ideas
21 Nov 14 11:43:23
$IWM $SDS $VXX Where do you want to go? $SPY http://t.co/I0LUnKrnpw
Iskounta
21 Nov 14 11:43:23
$SPY chart: $IWM $SDS $VXX Where do you want to go?. http://t.co/NYhmasdWW4
Old Dog New Tricks
21 Nov 14 11:37:50
Rolled 40 x $VXX Dec 12 29 C in/down to Nov 28 29 C @ .69 DB
Old Dog New Tricks
21 Nov 14 11:37:22
Rolled 10 x $VXX Dec 12 29 C in/down to Nov 28 29 C @ .67 DB
Old Dog New Tricks
21 Nov 14 11:36:58
Rolled 10 x $VXX Dec 12 30 C in/down to Nov 28 28.5 C @ .37 DB
Stockaholics
21 Nov 14 11:25:19
578% Gains On Penny Stocks in one month! Plus a New Pick Is Coming: http://t.co/2W3yKD2d5Q $LODE $VXX $RMKR
Mathew Humphries
21 Nov 14 11:06:52
RT @BlockTradeAlert: BLOCK TRADE: $VXX 500,000 shares @ $27.90 [14:05:50]
BlockTradeAlert
21 Nov 14 11:05:50
BLOCK TRADE: $VXX 500,000 shares @ $27.90 [14:05:50]
Eternity101
21 Nov 14 11:04:01
RT @selling_theta: $VXX still deep red because of what DEC $VIX did from 4-4:15 yesterday. This happens a lot. You must understand VIX mo…
TV_Trading Ideas
21 Nov 14 10:54:37
$SPY $SDS $VXX This candle is a bad candle! $IWM http://t.co/1IpY0aRi62
Iskounta
21 Nov 14 10:54:37
$IWM chart: $SPY $SDS $VXX This candle is a bad candle!. http://t.co/CIlEYLwqJu
chartguy89
21 Nov 14 10:41:52
HYG Stock Chart $HYG $TITXF $VXX $HAL http://t.co/3UX1jBvmZ1 http://t.co/N2NpXW9Vhz
Annie
21 Nov 14 10:38:45
There are a lot of similarities in current $SPY and $VXX charts vs. Sept high
selling_theta
21 Nov 14 10:37:41
$VXX still deep red because of what DEC $VIX did from 4-4:15 yesterday. This happens a lot. You must understand VIX movements to trade VXX
Johnny
21 Nov 14 10:34:01
@Taarriqq $VXX has had a 15 cent range the last 3 hours guys.
Cutlass
21 Nov 14 10:33:21
RT @Taarriqq: $VXX $VIX big bounce BOOM , day trade paying as $spy almost filled gap #ATM MACHINE ON
blackmarkt
21 Nov 14 10:31:55
L 27.60 +.51 RT @blackmarkt: $VXX chart: Swing Long VXX. http://t.co/etVYjx5iWE
OPTIONS/STOCK EXPERT
21 Nov 14 10:31:51
$VXX $VIX big bounce BOOM , day trade paying as $spy almost filled gap #ATM MACHINE ON
TraderMK
21 Nov 14 10:22:47
Ended up buying $SPY puts instead of $VXX calls. I think it's a better trade. No real moment on $vxx.
Sa Marki
21 Nov 14 10:11:36
@Taarriqq $VXX down too?
OPTIONS/STOCK EXPERT
21 Nov 14 10:04:32
$SPY gap fill in progress, $VXX entry bam #stockoptionexpert
Stock_Ninja
21 Nov 14 09:59:06
Strangely, no bounce today. Maybe later? $SPY $VIX $VXX
				
				
By  +Follow October 14, 2013 8:46AM
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