VIX CBOE Volatility Index Definition, Trading, & Limitations

When VIX returns are higher, market participants are more likely to pursue investment strategies with lower risk. VIX options are derivative securities that grant the holder the right, but not the obligation, to buy (call option) or sell (put option) the VIX at a predetermined price before a specific date. This inverse relationship makes the VIX an invaluable tool for gauging market sentiment.

But VIX-tracking funds are typically used by day traders and tend to be extraordinarily risky. The VIX can help investors predict short-term performance, but the fluctuations shouldn’t concern long-term investors. First introduced by the Chicago Board Options Exchange (Cboe) in 1993, the initial version of the VIX reflected a rolling 30-day calculation of at-the-money implied volatility (IV) on S&P 100 Index Supermarket stocks (OEX) options. This calculation is no longer widely used or tracked, but the “old VIX” is still available under the ticker symbol VXO.

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 best adr indicator for mt4 investing in diversified, low-cost index funds and letting dollar-cost averaging smooth out any pricing swings over the long term. Prices are weighted to gauge whether investors believe the S&P 500 index will be gaining ground or losing value over the near term. The CBOE Volatility Index—also known as the VIX—is a primary gauge of stock market volatility.

What Is the CBOE Volatility Index (VIX)?

Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. VIX futures are contracts that allow traders to speculate on the future direction of the VIX index. These futures contracts have monthly expirations and can be used for hedging or speculating on future changes in market volatility.

The VIX, formally known as the Chicago Board Options Exchange (CBOE) Volatility Index, measures how much volatility professional investors think the S&P 500 index will experience over the next 30 days. Market professionals refer to this as “implied volatility”—implied because the VIX tracks the options market, where traders make bets about the future performance of different securities and market indices, such as the S&P 500. By indicating the market’s anticipated volatility, it provides a sense of the risk and uncertainty perceived by investors, which can inform decisions around risk tolerance, asset allocation, and portfolio diversification. When investors trade options, they are essentially placing bets on where they think the price of a specific security will go. In many cases, large institutional investors will use options trading to hedge their current positions. So, if the big firms on Wall Street are anticipating an upswing or downswing in the broader market, they may try to hedge against that volatility by placing options trades.

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1. Moreover, by observing the VIX, investors can gain insights into the market’s risk and fear levels, helping them make more informed investment decisions.
2. The VIX attempts to measure the magnitude of price movements of the S&P 500 (i.e., its volatility).
3. “When the VIX is low, look out below!” tells us that the market is about to fall and that implied volatility is going to ramp up.
4. After 2002, CBOE decided to expand the VIX to the S&P 500 to better capture the market sentiment.
5. When the VIX declines, investors are betting there will be smaller price moves up or down in the S&P 500, which implies calmer markets and less uncertainty.
6. Before investing in any VIX exchange-traded products, you should understand some of the issues that can come with them.

High VIX levels usually indicate increased fear, while low levels suggest complacency, helping to gauge the pulse of the market. Furthermore, VIX-related products can be susceptible to contango, a situation where the futures price is higher than the expected future spot price, which can lead to losses over time. It should be noted that these are rough guidelines ⏤ unexpected events can throw a wrench into markets and a low VIX level today could be followed by a period of extreme volatility if circumstances change. 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.

Relationship Between the VIX and Stock Market

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. As such, many analysts and market watchers track the VIX as a contemporaneous indicator of investor sentiment, and it’s often referred to casually as the “fear gauge.” Sentiment plays a big role in decision making for the stock markets, and to that extent, it could be a good idea to glance at the VIX. However, the index is far from perfect, and investors should consider how much weight they want to peg on it. The VIX is considered a reflection of investor sentiment, but one must remember land fx and vectorworks comparison that it is supposed to be a leading indicator.

However, it’s impossible to purchase a basket of securities that track the VIX. 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.