Understanding the Impact of VIX on Market Volatility
A higher VIX means higher prices for options (i.e., more expensive option How to buy crypto without fees premiums) while a lower VIX means lower option prices or cheaper premiums. Such VIX-linked instruments allow pure volatility exposure and have created a new asset class. Instead, investors can take a position in VIX through futures or options contracts, or through VIX-based exchange-traded products (ETPs).
It’s important to emphasize, however, that the VIX measures implied volatility, i.e., the level of volatility the market is anticipating. Although the index can provide helpful information, investor sentiment isn’t always correct. In fact, the VIX tends to overestimate market volatility by about 4% to 5% on average, according to Fidelity. It tends to rise during times of market stress, making it an effective hedging tool for active traders. Though it can’t be invested in directly, you can purchase ETFs that track the VIX. When its level gets to 20 or higher, expectations are that volatility will be above normal over the coming weeks.
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In August 2024, the VIX jumped above 60, a level not seen since the market meltdown in the initial stages of COVID-19 in March 2020, as worries grow about a possible recession. The VIX index tracks the tendency of the simplefx forex broker review S&P 500 to move away from and then revert to the mean. When the stock markets appear relatively calm but the VIX index spikes higher, professionals are betting that prices on the S&P 500—and thereby the stock market as a whole—may be moving higher or lower in the near term.
- The CBOE Volatility Index—also known as the VIX—is a primary gauge of stock market volatility.
- That much is understood by most investors, but what exactly is volatility and how is it measured for the overall stock market?
- Traders making bets through options of such high beta stocks utilize the VIX volatility values in appropriate proportion to correctly price their options trades.
- You may have seen references to something called the VIX, an index that measures volatility, during times of extreme financial stress.
What is the Cboe Volatility Index (VIX)?
When you see the VIX above 30, that’s sometimes viewed as an indication that markets are very unsettled. Following the popularity of the VIX, the CBOE now offers several other variants for measuring broad market volatility. Options and futures based on VIX products are available for trading on CBOE and CFE platforms, respectively. Volatility values, investors’ fears, and VIX values all move up when the market is falling. The reverse is true when the market advances—the index values, fear, and volatility decline.
Products based on other market indexes include the Nasdaq-100 Volatility Index (VXN); the CBOE DJIA Volatility Index (VXD); and the CBOE Russell 2000 Volatility Index (RVX). The VIX was the first benchmark index introduced by CCOE to measure the market’s expectation of future volatility. Since the possibility of such price moves happening within the given time frame is represented by the volatility factor, various option pricing methods (like the Black-Scholes model) include volatility as an integral input parameter. The second method, which the VIX uses, involves inferring its value as implied by options prices. Options are derivative instruments whose price depends upon the probability of a particular stock’s current price moving enough to reach a particular level (called the strike price or exercise price). In addition to being an index to measure volatility, traders can also trade VIX futures, options, and ETFs to hedge or speculate on volatility changes in the index.
It’s possible to buy futures contracts or exchange-traded funds (ETFs) and exchange-traded notes that own these futures contracts in an effort to mirror the index. Because the volatility index tends to rise when the S&P 500 falls, investors might do so if they’re bearish on the stock market. Or they may take a position in a VIX-linked product for portfolio diversification or as a hedging strategy. The VIX is calculated using average weighted real-time call and put prices across the S&P 500 index with an expiration date of between 23 and 37 days out.
Historical VIX levels
But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you. For instance, a stock having a beta of +1.5 indicates that it is theoretically 50% more volatile than the market. Traders making bets through options of such high beta stocks utilize the VIX volatility values in appropriate proportion to correctly price their options trades. 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. Only SPX options are considered whose expiry period lies within more than 23 days and less than 37 days.
Does the Level of the VIX Affect Option Premiums and Prices?
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 finally, the standard deviation on the historical price data sets. During winter 2013, a time of strong stock market performance, the VIX was at around 12. But in March 2020, as a global panic about the COVID-19 pandemic peaked, the index reached a record 82.69.
In times of uncertainty, investors will pay a premium for what’s essentially a form of insurance. Higher options prices across the overall stock market indicate that investors expect heightened volatility. The Chicago Board Options Exchange Volatility Index, or VIX, is an index that gauges the volatility investors expect in the U.S. stock market.
As exchange-traded products, you can buy and sell these securities like stocks, greatly simplifying your VIX investing strategy. It’s important to note here that while volatility can have negative connotations, like greater risk, more stress, deeper uncertainty or bigger market declines, volatility itself is a neutral term. Greater volatility means that an index or security is seeing bigger price changes—higher or lower—over shorter periods of time.
Get stock recommendations, portfolio guidance, and more from The Motley Fool’s premium services. Investing in the VIX directly is not possible, but you can purchase ETFs that track the index as a way to speculate on future changes in the VIX or as a tool for hedging. This isn’t something that will make sense for most investors who are working to meet a long-term goal such as saving for retirement. Miranda Marquit has been covering personal finance, investing and business topics for almost 15 years. She has contributed to numerous outlets, alpari review including NPR, Marketwatch, U.S. News & World Report and HuffPost.
