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What Is the CBOE Volatility Index (VIX)?

Sebencapital

Published
08/01/24
What Is the CBOE Volatility Index (VIX)?

DEFINITION:

The CBOE Volatility Index (VIX) is a measure that follows how much the stock market in the United States changes. It focuses on predicting how much the S&P 500, a stock market index, might change based on certain types of options called call and put options.

Definition of The CBOE Volatility Index (VIX)

The VIX is a measure developed by Cboe Global Markets in 1993. It shows how much the US stock market might change soon. People worldwide use it to understand how volatile the stock market is – higher VIX levels mean more volatility.

Similar to other indexes that follow groups of stocks or securities, the VIX measures volatility by looking at a group of securities. It watches call and put options connected to the S&P 500 with expiration dates set 30 days ahead.

Alternate name: The "Fear Gauge" or "Fear Index"

The VIX formula is quite complicated. In simple terms, if more people want put options, the VIX goes up. This shows that investors predict more ups and downs in the future.

How Does the CBOE Volatility Index (VIX) Work?

The CBOE Volatility Index (VIX) keeps an eye on how much the stock market might change by looking at S&P 500 options. When the stock market is predicted to get more volatile, the VIX goes up using a complex formula. And when it's expected to calm down, the VIX goes down.

Note

The VIX serves as a gauge of how confident or worried investors are about the market. If investors are concerned, the VIX goes up. When they feel confident, it goes down. That's why some people call it "the Fear Gauge."

Investors trade VIX-related derivatives for various reasons.

For instance, if someone thinks the stock market will become more unpredictable, they can buy VIX futures at a higher price than it is now. Likewise, if they expect less unpredictability, they can use these financial tools to benefit.

Investors often use the VIX to protect their investments. Normally, when the stock market drops, the VIX goes up, and when the market goes up, the VIX goes down. This opposite movement helps investors balance their portfolios.

Note

Although the VIX generally moves opposite to the stock market, sometimes it moves in the same direction. This means investors shouldn't always count on it as a surefire way to protect their investments.

Investors looking to protect against market drops can buy call options or sell put options related to the VIX. If the market falls, the VIX usually goes up, allowing investors to gain from these options, which helps recover some of their investment losses.

Do I Need the CBOE Volatility Index (VIX)?

The VIX index offers investors unique ways to use investment strategies that might be tricky to do otherwise.

If you believe that fear and market unpredictability will increase, the VIX helps you make money from that idea. It's not easy to invest in a way that benefits from market ups and downs without using VIX-related investments.

Some investors see the VIX as a sign of how scared investors are and what might happen to stocks in the future. When the VIX goes up, it often means more fear among investors, hinting at possible drops in stock prices. Even if you don't directly deal with VIX-related investments, the index can be a useful signal for making other trades.

What It Means for Individual Investors

Regular investors can utilize the VIX in various ways. One easy way is to view it as a sign of future overall market changes. Since the VIX often follows how investors feel, you might predict future market ups and downs by watching how the VIX moves.

Note

Certain individual investors might wish to invest in the VIX directly. Although you can't purchase shares of the index itself, you can invest in VIX-related derivatives or exchange-traded products that follow the VIX.

VIX Futures

Although trading derivatives is often seen as riskier than trading stocks, VIX futures come with a specific risk called "contango." In contango, futures contracts linked to the VIX are usually priced higher than the current VIX or short-term contracts. If you're aiming to invest in the VIX for your portfolio, you might end up purchasing more expensive futures contracts as the current ones in your portfolio reach their end date.

VIX Exchange Traded Products

Small investors who prefer avoiding the complications of options and other complicated financial products might consider purchasing shares in VIX exchange-traded products when they anticipate market volatility.

These products could be Exchange-Traded Notes (ETNs) or Exchange-Traded Funds (ETFs) structured as pooled investments or limited partnerships.

Key Takeaways

  • The VIX gauge shows how much the stock market is expected to change unpredictably.
  • The VIX calculates how unpredictable the stock market might be by looking at calls and putting options related to the S&P 500, which have 30 days left before expiration.
  • Investors cannot directly invest in the VIX itself, but they can invest in ETFs that follow it or in derivatives related to it.

Written by Sauravsingh

Techpreneur and adept trader, Sauravsingh Tomar seamlessly blends the worlds of technology and finance. With rich experience in Forex and Stock markets, he's not only a trading maven but also a pioneer in innovative digital solutions. Beyond charts and code, Sauravsingh is a passionate mentor, guiding many towards financial and technological success. In his downtime, he's often found exploring new places or immersed in a compelling read.

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