The calculation method of the VIX index is relatively complex, as it doesn’t simply track past market volatility but predicts future volatility based on options market pricing. This forward-looking characteristic gives the VIX index certain warning capabilities. When the VIX index shows abnormal changes, it often indicates potential significant market changes.
How the VIX works to forecast market volatility
Simply put, the VIX index reflects market participants’ expectations of potential volatility in the U.S. stock market over the next month. This index is calculated based on S&P 500 index option prices, extracting the implied market expected volatility from option prices through complex mathematical models to form a percentage value. For example, if the VIX is at 20, it indicates that the market expects an annualized volatility of 20% for the S&P 500 index over the next 30 days.
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- During the 1987 Black Monday crash, estimates suggest the index would have reached approximately 150 had it existed then.
- Investors can judge the level of market panic by observing changes in the VIX index and adjust their investment strategies accordingly.
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Traders can use VIX futures, options, and ETFs to hedge or bet on changes in the index’s volatility.In general, volatility can be measured using two different methods. The first method is based on historical volatility, using statistical calculations on previous prices over a specific time period. This process involves computing various statistical numbers, like mean (average), variance, and the standard deviation on the historical price data sets.
CBOE launched the first VIX-based exchange-traded futures contract in March 2004, followed by the launch of VIX options in February 2006. During times of market volatility, it can be especially helpful to get expert advice. Connect with a Thrivent financial advisor today to discuss how they can help you stay focused on your long-term goals, no matter what the market brings. The Chicago Board Options Exchange Volatility Index, commonly known as the VIX, emerged in 1993 as a groundbreaking tool that would forever change how investors measure and interpret market fear.
What the VIX reveals about the market’s future
Without getting too technical, the VIX comes from a mix of S&P 500 options that expire at different times. It uses a weighted average of their implied volatilities, focusing on out-of-the-money options which tend to react more strongly to changes in sentiment. The final figure is expressed as a percentage that reflects the expected 30-day volatility of the S&P 500.
How Can an Investor Trade the VIX?
Commissioned by the CBOE and developed by Professor Robert Whaley, the index initially focused on S&P 100 (OEX) options before evolving into its current form. Investing involves market risk, including possible loss of principal, and there is no guarantee that investment objectives will be achieved. VIX values are calculated using the CBOE-traded standard SPX options, which expire on the third Friday of each month, and the weekly SPX options, which expire on all other Fridays.
Downside risk can be adequately hedged by buying put options, the price of which depends on market volatility. Astute investors tend to buy options when the VIX is relatively low and put premiums are cheap. Volatility is one of the primary factors that affect stock and index options’ prices and premiums. As the VIX is the most widely watched measure of broad market volatility, it has a substantial impact on option prices or premiums. A higher VIX means higher prices for options (i.e., more expensive option premiums) while a lower VIX means lower option prices or cheaper premiums.
How do you trade the VIX?
So if the VIX is lower compared to recent levels, it may be considered a low value for that time period. Active traders who employ their own trading strategies and advanced algorithms use VIX values to price the derivatives, which are based on stocks with high beta. Beta represents how much a particular stock price can move with respect to the activity of the broader market index. Instead, investors can take a position in VIX through futures or options contracts, or through VIX-based exchange-traded products (ETPs). Because option prices are public, they can be used to determine the volatility of an underlying security. Such volatility, as implied by or inferred from market prices, is called forward-looking implied volatility (IV).
Morgan Wealth Plan can help focus your efforts on achieving your financial goals. Through Wealth Plan, you can connect with an advisor to help you create a plan, adjust your financial strategy, and track your progress. Funding for education can come from any combination of options and a J.P.
- Simply put, the VIX index reflects market participants’ expectations of potential volatility in the U.S. stock market over the next month.
- However, news breaks that a major global event (e.g., a geopolitical crisis, a major economic announcement) is imminent.
- Spikes in the VIX are often temporary responses to short-term uncertainty.
- Such VIX-linked instruments allow pure volatility exposure and have created a new asset class.
The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely.
Comparing VIX Movements With S&P 500 Trends
During periods of great uncertainty, such as the 2008 financial crisis and the COVID-19 pandemic’s onset in 2020, the VIX hit end-of-month peaks in the 50s, according to the Federal Reserve of St. Louis. When the VIX rises to such high values, that means investors expect greater market volatility in the near future. It’s a contract that allows investors to buy or sell a certain security at a certain price until a certain time—it’s like a bet on which way they think an investment’s price will move. Cboe uses the real-time data from options prices and quotes on its exchange to create a measure of how much the S&P 500’s price is expected to move in the near future. Such VIX-linked instruments allow pure volatility exposure and have created a new asset class.
High VIX readings don’t automatically signal market bottoms, nor do low readings immediately precede tops. The index can remain at elevated or depressed levels much longer than investors expect, and using it in isolation for market timing often leads to premature or misguided investment decisions. Another common misunderstanding is treating VIX levels as absolute indicators that mean the same thing in all market conditions. What constitutes a “high” or “low” VIX reading varies significantly depending on the broader market environment, economic conditions, and historical context. A VIX reading of 20 might be considered high during a calm bull market but relatively low during periods of economic uncertainty.
Unless otherwise noted, the opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates. affiliate networks list As the derivatives markets matured, 10 years later, in 2003, the CBOE teamed up with Goldman Sachs and updated the methodology to calculate the VIX differently. Also called the “fear index,” the VIX was created in 1993 by the Chicago Board Options Exchange and is formally known as the CBOE Volatility Index. “Chase Private Client” is the brand name for a banking and investment product and service offering, requiring a Chase Private Client Checking℠ account.