As you would expect with the sudden introduction of volatility into the market, the VIX index has shot up. The VIX is like that embarrassing relation that only turns up to family functions now and again, but always creates an impression when he does! In this case the VIX index has been very quiet, ambling along at just over 10 for the last few months, but since early February it has gone berserk.
This is not surprising as the VIX is a measure of implied volatility in the market using as its basis open options on the S&P 500. In some ways it is a benchmark of uncertainty about the future direction of US stock prices. Some call it the Fear Index. What it is telling us right now, as it climbs as high as 50 on some days, is that there are a lot of traders out there who are uncertain about the direction of US stock prices.
The VIX Index – a measure of panic in the market
The VIX index has been around since 1993, but following its performance during the Great Financial Crisis in 2008, when the world teetered on the brink of financial Armageddon, many investors and journalists have woken up to its value as a measuring stick of the level of fear in the market.
At the time of writing, the VIX was dropping rapidly into the 20s, which would seem to indicate that anxiety is withdrawing again.
Trading the VIX index
But can you trade the VIX? As it happens, yes you can. It is possible to open a financial spread bet or Contract for Difference which uses the VIX price as its underlying. There is little point in doing this most of the time, as the VIX is fairly moribund when the stock market is doing well. But as we have seen in the last 10 days, the price can go up quite substantially.
It is important to understand that the VIX measures the open options on a 0-100 absolute range, hence you are not going to see it at 110, and if it gets up to 70-80 it may be time to think about buying tinned food and gold bullion. The fact that the VIX index hit 50 on 6 February was a good indicator of just how jumpy the banks and traders out there were feeling.
Since then we have seen a doubling of the price of the VIX from 20 to 40 in the space of 48 hours as initial market relief on the rally of 7 February evaporated. Subsequent trading activity has seen the VIX decline again, but we’d argue the market is still jumpy and that caution is going to translate into more open options in the near future. Remember, it is the degree of fear in the market you are trading with the VIX, not an inverse trajectory to S&P 500 stock prices.
Short term trading opportunity
The VIX represents an interesting market to trade when there is a high degree of volatility like there is now, but these trades are only worth keeping open for short periods of time, like the 48 hours we saw last week. The VIX index is also a good market to look at when stocks go into free fall, as options activity will pick up dramatically then.
Before opening a VIX trade, it is worth acquainting yourself with historical chart activity and how the VIX performs against the S&P 500. The period 2008-09 is particularly educational, but the market is different now than it was then, so more recent activity should be accorded more weight. In particular, check out the trading period in August 2015 when the VIX last spiked to this degree. And remember to keep your stops fairly wide for this one, as it can bounce up and down quite a bit during periods of panic.