What's the VIX - And Why Does it Matter to Traders?

optionsguy posted on 08/03/11 at 02:45 PM

TradeKing's "Options Guy" Brian Overby explains the VIX, the market's "fear factor" barometer

Market pundits love to speculate about exciting or uncertain scenarios, from the debt ceiling to the possibility of a new bubble. And when those prognosticators talk about risky or fear-inducing scenarios, they also like to invoke something called the "VIX". What is the VIX - and what does its action matter to traders and investors?

The VIX's nickname is the "fear factor". In a nutshell, it's a market measure that gauges the aggregate level of fear or uncertainty among investors at a given point in time.

That's a pretty handy trick, you might be thinking. But how does the VIX actually calculate something as intangible as fear? The VIX was designed to be a consistent, 30-day benchmark of expected market volatility (implied volatility), as measured by using At-the-Money S&P 500 index (SPX) option prices. The VIX itself signals broad market uncertainty, with a higher VIX suggests elevated fear among investors and a lower VIX the opposite.

VIX options can be used to speculate on how volatile the entire market place will be as a whole. In other words, VIX options' activity can suggest an answer to the question: will the implied volatility of the market increase or decrease in the future?

It sounds like a simple idea, and certainly a useful one. But it's important that you understand the VIX more thoroughly - particularly VIX-based options, which can be tricky - before any trading based on it. I've discussed VIX-based options in a two-part series, Decoding the VIX I and Decoding the VIX IIThe Trickery of VIX Calls is another useful read on this often-confusing subject. 

When the VIX makes a big move upward or down, it can be handy to be acquainted with strategies specifically geared to take advantage of those conditions. My post How can you trade the plunging VIX? addresses the downside approach. When the VIX says "bail", not "buy" explores some other subtleties in interpreting the VIX's action. 

Brian Overby 
TradeKing's Options Guy 

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Posted by optionsguy on 08/03/11 at 02:45 PM

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clecavs posted August 05, 2011 (07:15PM)


Both of the Decoding the VIX links do not seem to work. Please re-check.


optionsguy posted August 08, 2011 (04:22PM)

Sorry BA,

Here are the direct link to the Blogs. Please cut and paste directly if the link does not work.



The part two does give the most detail.

Brian (Og)

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