The VIX measures the implied volatility of a set of options associated with an index. Better known is the CBOE Volatility Index, which calculates the VIX as a result of the implied volatility of SP&500 option prices.
Maybe this sounds a bit Chinese. In short, the VIX index is known as the volatility index or ‘fear index’. Let’s go by parts:
1. What does the VIX index measure?
Measures the volatility of Chicago Board Options Exchange (CBOE) options on the SP&500 (Standard & Poor’s 500) index, which includes 500 companies.
That is, basically the VIX represents the volatility of the monthly call options and put options on the SP500.
Is this important? The way I see it, volatility is one of the best indicators out there.
2. History of the creation of VIX Futures
Well, to understand the creation of VIX Futureswe need to go back to the first research on the volatility of financial markets.
The pioneers in this research, Menachem Brenner and Dan Galai, created the first volatility index in 1986.
Originally, Brenner and Galai planned to call the volatility index Index Sigma after the symbol sigma which refers to volatility in the mathematics of the financial world.
And it was in 1992, when the Chicago Board of Options Exchange began its own research on volatility and the creation of an index based on it.
Et voilá, in 1993 Professor Whaley created the VIX volatility index.
3. Why is it called the fear index?
To discover why it is called the “fear index”, it is necessary that we go to all those moments of market panic.
Here I leave you some of them:
1- In 1998, the VIX reached 60 when the Russian financial markets crashed.
2- In 2001, after the attacks of September 11, the price of the VIX index exceeded 58 points.
3- In 2002, the series of financial scandals that began with Enron led the VIX to 58 points between July and November.
4- In 2008, when the subprime mortgage crisis broke out, andl indvolatility ice reached 79 points in October.
5- In 2022, in full doubt of a financial fissure, the VIX reached 50.30 points on February 6.
6- Finally, another noteworthy case is that of last year, during the months of March and April, in which the VIX index remained above 40 points, even exceeding 80 points on March 18, level historical, mainly due to all the news related to the coronavirus, and the consequent collapse of the markets
4. How to interpret the VIX
In markets, volatility represents confidence or fear.
When the VIX is trending towards 0, it reflects a sentiment of investor confidence in the US economy.
When the VIX tends to 100, it reflects pessimism or fear on the part of these same investors.
5. How the VIX Volatility Index works
To know how the VIX volatility index works specifically, we must refer to the three levels of scope in the VIX CBOE:
- Between 0 and 20: There is little volatility in the market, investors are confident, and the S&P500 is initially in an uptrend.
- Between 20 and 30: Investors start to worry which leads to volatility, the SP500 uptrend may continue but also start to reverse.
- Between 30 and 100: it is panic on the part of investors! Volatility is particularly high and we are probably seeing a sharp correction or even a collapse in SP500 and major stock indices.
And this is already like everything, depending on the investor, each one works with different ranges. Some more cautious investors prefer to use the ranges: 0-15, 15-25 and 25-100, while more speculative investors prefer to consider the price ranges 0-25, 25-40, 40-100.
The VIX is used as a measure of expected short-term volatility given that the options listed today have a 30-day expiration. So those options are picking up today’s market sentiment through the next 30 days.
It is a matter of testing to create systems in different ranges and filters to take advantage of it.
6. Why trade the VIX
Mainly, you can consider whether to operate in VIX or not for 2 fundamental points:
CFD VIX contract duration. The maturity of the CFD contract on the Volatility Index Future is 1 month. Therefore, trading positions are automatically closed at the end of the contract.
The main advantage of these positions is the absence of swap commissions, which are overnight interest paid or earned for holding positions open overnight in Forex trading.
7. VIX Trading Hours
I divide the VIX into 2 hourly forks:
- From 00:00 to 22:15
- From Monday to Friday
The VIX trading hours are continuous for a very long period of time: from 00h to 22:15h and 5 days a week.
This schedule allows both night traders and “early risers” to quickly position themselves on the stock market without having to suffer the consequences of having an opening gap.
8. How to analyze the VIX index
I know that I am overwhelming you with a lot of information without stopping but, in this way, you can go to this post whenever you want and you will have everything at your disposal and well broken down by points.
Next I am going to tell you about the 3 ways to analyze the VIX index:
- VIX Trend Analysis
- VIX Price Action Analysis
- VIX Fundamental Analysis
8.1. VIX Trend Analysis
If we want to analyze the trend of the VIX we will have to focus on two factors:
- Time frame. The larger the time frame, the more relevant the identified trend is.
- trend indicator. It can be divided into an uptrend and a downtrend, depending on where prices are.
8.2. VIX Price Action Analysis
On the other hand, the VIX index is also sensitive to price analysis, which can help you interpret possible movements of the VIX volatility index.
8.3. VIX Fundamental Analysis
Let’s not forget that the VIX is above all an indicator of volatility and what we know as the fear index of the markets.
Therefore, it is also particularly sensitive to economic announcements and the geopolitical context affecting the markets.
The main economic announcements that influence the price of the VIX are:
As an incentive, in the current context, we can also highlight the role of the coronavirus pandemic, which is causing strong variations in the markets.
When the cases began to spread and the restrictions began, the volatility in the markets increased considerably, and therefore the price of the VIX.
This is what underscores this indicator as the Fear Index.
However, we can see that when solutions and media were implemented and the markets began to recover from their falls, the volatility index began to decrease, remaining in a range between approximately 20 and 40 dollars.
After everything exposed and told above, one of the conclusions we can draw is that of the imminent and continuous flow and movement of the VIX from its birth until now.
Therefore, you should be interested in what we can expect from the VIX in different scenarios.
Although we cannot know its movement exactly as we cannot know it in any other asset or unexpected event, it is true that we can include it as an indicator or filter in our trading systems.
If we expect volatility, we should at least take into account our risk tolerance for the assets in which we are exposed. To understand the VIX index it is important to know the concept of the exercise price, that is, the price at which the owner of the option can buy or sell. Also that it is one of the financial instruments of reference in the stock markets.
We must ask ourselves if we are willing to see our positions fall by a certain % and in that case what plan can we follow so as not to end up selling at the worst moment surprised by the volatility.
From there, enjoy and try your strategies, only then can you move forward and find out what trader you are and/or want to become.
Thanks for getting here.
We will read each other in the next one.