What is the VIX index

How to use the VIX index in trading

The VIX Index is one of the most reliable tools if you want to correctly record entries and exits in trading.

 
Granted, the name VIX doesn't exactly sound like a serious trading vehicle.

And of course, if you've never heard of him, you wonder:

"What does the name stand for anyway?"

VIX means "Volatility Index".

 

What is the VIX and how does it work?

 
The VIX is a minute-by-minute index of the market assessment of the implied (expected) volatility of the American S&P 500 Index (SPX).

More precisely, the VIX index is a momentary measure of how much the S & P500 index will fluctuate over the next 30 days from the time of the last tick of the VIX index.

The Chicago Board Options Exchange (CBOE) calculates the VIX Index using standard SPX options and weekly SPX options that are admitted to trading on the CBOE. Standard SPX options expire on the third Friday of each month and weekly SPX options expire on all other Fridays.

These SPX options therefore form a constant 30-day measure of the expected volatility of the S&P 500 Index.

CBOE calculates the VIX index approximately every 15 seconds during normal and extended trading hours for SPX options according to the established VIX formula. The daily opening value for the VIX Index is set at approximately 02:15 am (CT).

Do you want to see the formula? May I help you:
 

 

 

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Now there is still the question of what exactly the VIX Index should bring us in trading.

You will find out in a moment.

Because the VIX index measures the level of expected volatility of the S&P 500 over the next 30 days of the implied SPX options, it seeks to predict the fluctuations of future market movements.

This is in contrast to actual volatility, which measures the variability in historical (or known) prices.

 

There is a well-known and proven saying:

If VIX is high, it's time to buy. If VIX islow, it's time to go.

 

A whole lot of input can be taken from this simply threshed phrase.

Because this sentence says nothing else than that you should avoid (or short) the stock market when the VIX is low and that you should buy stocks as soon as the VIX is high.

In banal terms:

 

The VIX is a fear barometer!

When it is low, speculators are too euphoric and all go long. Since the mass is usually wrong, we are then on the verge of a trend reversal. Likewise in the opposite case, if the market is fearful due to a crash or a protracted downtrend. Then the VIX will be high and it will be worthwhile to be the first to go shopping again.

 

You can see that the index was between 12 and 40 points over the past 12 months. In the next chart we can see how these values ​​are to be classified. Incidentally, it cannot fall to 0 ...

The VIX is therefore an index that correlates negatively with its underlying “parent index”, the S & P500.

 

In other words, if the VIX rises, the S & P500 falls and vice versa.

Now we just have to know who “twitches” first and who follows whom well. Because only then can we derive and implement trading ideas.

Can you prove that somehow?

Yes you can. The following chart shows the development of the S & P500 and the VIX at the same time. Even if this graphic is a bit older, it shows very nicely that the VIX behaves in the opposite direction to the S & P500.

And if you look closely you will see something much more important:

The VIX seems to be a few bars ahead of the S & P500. When the VIX hits its low point, the S & P500 falls shortly afterwards.

 

Of course, you ask yourself how you can benefit from this knowledge in your own trading. And yes, there are several ways to trade the VIX.

 

Can you trade the VIX?

 

In contrast to the S & P500, which consists of a relatively stable portfolio of stocks, the VIX index is constantly being reassembled. Usually every single minute. As if I can hardly manage to keep this rebalancing constant.

However, there are some financial products on the market that map the VIX. On closer inspection, however, it is the VIX Future!

But it is also clear that many of the certificates and ETFs on the VIX are subject to constant rollover losses.

If I want to trade the VIX then I should have a very short time horizon (a few days or a few weeks).

In times of crisis, financial products on the VIX are of course a strong guarantee of success, especially when the shares are falling quickly and steeply. In quiet times, however, things look extremely bad for the financial product (not necessarily for the VIX).

Many market participants, especially institutional investors, use the VIX Future to hedge their portfolios. But only very few are successful.

 

So I have the option of trading the VIX Index directly, or just using it as a warning signal for a trend reversal.

For private traders, I recommend using the VIX only as a mood barometer and not investing directly in VIX products. You can watch various products in a watchlist and only invest once you have fully understood how they work.

For all those who are wondering whether the VIX is also helpful for assessing the DAX, I can only say: Remember that the S & P500 is the leader of the stock markets and that the DAX will not (sustainably) rise if the S & P500 falls!