The VIX is merely a suggestion, and it’s been proven to be wrong about the future direction of markets nearly as often as it’s been right. That’s why most everyday investors are best served by regularly investing in diversified, low-cost index funds and letting dollar-cost averaging smooth out any pricing swings over the long term. There’s no crystal ball for the stock market, but there are indexes that help investors gauge expected risk. It can offer a sense of future volatility, or how bumpy things could get, for the US stock market over the next 30 days. Learn how the VIX works, how it’s calculated, and what a high or low VIX could mean for your investments. When stock market turbulence strikes, and investor emotions fluctuate like a roller coaster, market volatility becomes a pressing concern.
- Although the index can provide helpful information, investor sentiment isn’t always correct.
- The VIX measures the market’s expectations for volatility over the next 30 days based on the bid and ask prices of S&P 500 index options (called the SPX options).
- Understanding how to interpret and apply the VIX can significantly enhance trading performance.
- While a rising VIX can indicate increasing risk, it is not a definitive predictor of market crashes but rather signals heightened market uncertainty.
The more dramatic the price swings in the index, the higher the level of volatility, and vice versa. The VIX tends to revert to its long-term average over time, known as mean reversion. Spikes in the VIX are often temporary responses to short-term uncertainty. Yes, investors often use the VIX as a hedge against other portfolio assets, speculating on or mitigating the impact of volatility. Yes, there are several ETFs and ETNs designed to track VIX futures, offering exposure to volatility without directly trading options or futures.
- Generally, the higher the VIX (as a result of increased options demand and thus prices), the less certainty investors have about future prices in the US stock market over the next 30 days.
- Yes, there are several ETFs and ETNs designed to track VIX futures, offering exposure to volatility without directly trading options or futures.
- Generally speaking, if the VIX index is at 12 or lower, the market is considered to be in a period of low volatility.
What the VIX reveals about the market’s future
The VIX was the first benchmark index introduced by CBOE to measure the market’s expectation of future volatility. Throughout its existence, the VIX has served as eToro Review an invaluable witness to major market events. During the 1987 Black Monday crash, estimates suggest the index would have reached approximately 150 had it existed then. More recently, it hit dramatic peaks of 89.53 during the 2008 Financial Crisis and 82.69 amid the 2020 COVID-19 market crash. In normal market conditions, the VIX typically oscillates between 15 and 20, with readings above 30 signaling significant market stress. The information herein is general and educational in nature and should not be considered legal or tax advice.
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Lastly, traders might neglect to use the VIX alongside other indicators. These dramatic increases were short-lived, and the index eventually returned to more typical levels. 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. Miranda Marquit has been covering personal finance, investing and business topics for almost 15 years.
Understanding the CBOE Volatility Index (VIX) in Investing
A fourth error involves failing to consider the context, such as economic events or geopolitical tensions that impact market volatility. The VIX spikes during periods of uncertainty, like the Global Financial Crisis or the COVID-19 pandemic, signaling market turbulence. VIX options are contracts that give investors the right, but not the obligation, to trade the VIX futures at a predetermined price before expiration. The VIX is often called the “fear gauge” because it tends to rise when market uncertainty and fear increase, reflecting higher expected volatility. 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. 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.
In this article, we’ll delve into what the VIX measures, how it’s calculated, and whether you should use it in your investment decisions. Often referred to as the “fear gauge,” the VIX captures the market’s expectations of volatility over the next 30 days, as implied by options on the S&P 500 Index. When the VIX is high, it suggests that investors anticipate significant market changes, while a low VIX implies a stable, less volatile market outlook. The Cboe Volatility Index, or the “VIX,” is a measure of the US stock market’s 30-day expected volatility—or how much and how quickly stock prices are anticipated to change. It’s often called “the fear gauge,” since higher volatility is linked with higher uncertainty among investors. The index was created by the Chicago Board Options Exchange (aka Cboe, pronounced see-boh), which is a trading exchange like the New York Stock Exchange that’s focused on options contracts.
How to use the VIX to make better investment decisions
Greater volatility means that an index or security is seeing bigger price changes—higher or lower—over shorter periods of time. Options trading entails significant risk and is not appropriate for all investors. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request. However, the VIX can be traded through futures contracts, exchange-traded funds (ETFs), and exchange-traded notes (ETNs) that own these futures contracts. 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.
This expectation can stem from upcoming events or broader economic conditions. As a result, traders may adjust their strategies to manage risk, such as using options to hedge against possible losses. Conversely, a low VIX reading points to a stable market, suggesting less risk involved in current trades. Investors use the VIX to gauge market sentiment, manage risk, and inform trading and hedging strategies, especially in options trading.
In many cases, when the stock market goes down in price, the VIX increases. That said, the VIX is intended to measure short-term volatility rather than act as an index that’s always moving the opposite way as stock prices. 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.
The VIX has paved the way for using volatility as a tradable asset, albeit through derivative products. CBOE launched the first VIX-based exchange-traded futures contract in March 2004, followed by the launch of VIX options in February 2006. During winter 2013, a time of strong stock market performance, the VIX was at around 12.
When you purchase options, you’re buying the right (but not the obligation) to buy or sell a stock at a specified date and price. 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. Rather, it’s a leading indicator that measures the level of stock market volatility expected by investors.
Unlike historical volatility, which looks at past market movements, the VIX is forward-looking. It represents implied volatility, or the market’s forecast of future movement. This predictive nature makes the VIX a powerful volatility forecasting tool. When investors expect turbulence—whether due to economic data, earnings reports, geopolitical events or policy changes—they often buy more options to hedge their positions.