The VIX, also known as the “fear index,” is a popular market indicator used to measure the level of volatility in the stock market. This article discusses understanding it and how it can be used can help traders and investors improve their stock and options strategies.
What is the VIX?
The VIX, or the CBOE Volatility Index, is a measure of the market’s expectation of volatility in the S&P 500 index over the next 30 days. It is calculated using the prices of S&P 500 index options and reflects the market’s view of the likelihood of large moves in the stock market, either up or down. A high reading suggests that traders and investors expect the stock market to be more volatile in the near term, while a low reading suggests the opposite.
How to use it in stock trading
The VIX can be used as a gauge of market sentiment and as a way to gauge the risk associated with holding stocks. When the it is high, it suggests that traders and investors are concerned about a potential market downturn, and that stocks may be more vulnerable to sharp price declines. On the other hand when the VIX is low, it suggests that traders and investors are more optimistic about the market and that stocks may be less vulnerable to large price declines.
Using the VIX, traders and investors can adjust their stock portfolios based on their risk tolerance. If it is high, it may be a good idea to reduce exposure to stocks and instead allocate more capital to safer investments such as bonds. But if the VIX is low, traders and investors may consider increasing their exposure to stocks as the market is likely to be more stable.
How to use the VIX in options trading
In options trading, the Volatility Index can be used as a way for traders to buy and sell options based on their expectations of future market volatility. If a trader believes that it will rise, they can buy options that will increase in value as the VIX rises. Conversely if a trader believes the VIX will fall, they can sell options that will decline in value as it falls.
Another way to use the VIX in options trading is to estimate the level that is “implied” by the prices of options. By comparing the implied volatility of options to the actual historical volatility of the underlying stock or index, traders can gain insight into whether options are overvalued or undervalued. If options are overvalued traders can sell options to capitalize on the discrepancy, while if options are undervalued traders can buy options to take advantage of the opportunity.
Trader’s toolbox
Finally, both stock and options traders can fine tune the timing of their trades using the VIX. When it has moved between 10-15% higher than its 10 day moving average, this can be a good indication that the stocks may be ready for a short-term rally. Conversely, if the VIX has dropped 10-15% below its 10 day moving average this can be a good indication that the markets are ready for a short-term correction.
In conclusion, the VIX can be a valuable tool for traders and investors looking to improve their stock and options strategies. By using it to gauge market sentiment and volatility, traders can make more informed decisions about when to buy and sell stocks, and when to buy and sell options. However, it’s important to keep in mind that the VIX is just one of many market indicators and should be used in conjunction with other analysis and research to make the most informed decisions.