Many traders are getting frustrated at the moment with the ups and downs of US stocks as the market seeks to find some kind of direction. There is obviously a shake out happening in the tech stocks area where valuations had reached, frankly, fairy tale levels. But the broader indices are also misbehaving.
For short term traders this is making the market a tad unpredictable, especially with extraneous news flow also contributing to varying opinions from market investors.
What is certain, however, is there is a lot more fear out there in the market compared with December. And where there’s fear, there is also upside from the VIX index.
What is the VIX index?
I really started paying attention to the VIX when I was working at CMC Markets not long after the financial crisis of 2008-09. It is a great way to measure the levels of fear / negativity in US stocks and markets more generally, and is frequently cited on television news channels.
The VIX is calculated using S&P 500 index options with near term expiration dates, so is really a good gauge for market sentiment now, and out to about 30 days. It moves much more quickly than, say, the gold price, which has also been going up in recent days.
The VIX – aka the Cboe Volatility Index – was created by the Chicago Board Options Exchange and is maintained by Cboe Global Markets. It is important to note that the index is measuring expected rather than actual volatility in the S&P 500.
The index is measured between zero and 100. It has had two seriously high peaks historically. In October 2008 it reached 60 during the Lehman Brothers collapse. As the pandemic was spreading in March 2020 it hit 53.5. It has a tendency to surge during periods of extreme crisis.
What’s been happening with the VIX recently?
The VIX had been dropping under 30 in Q2 of last year, but we still saw some occasional spikes off a floor of around 16-17. This was largely being driven by panics around new mutations and waves of the virus over the course of the second half of last year, but again, it is a good illustration of the behaviour of the index when investors start getting scared and buy options.
Moving to the last week and we have seen the VIX come off the 22 level, driven we think by several factors, including the way the Netflix numbers have impacted the tech sector. The situation in Ukraine is also driving it. The panic on Monday drove the VIX up to over 37 points. This has been its most recent peak and things have since subsided considerably.
Instruments to trade the VIX
From a trading perspective, this is really a short term tool but one traders can reach for during periods when the main market is looking quite volatile. Quite a few brokers offer Contracts for Difference based on the price of the VIX, which is the easiest way for traders to access this price action with leverage. They can also be used to go short VIX when it drops as things get quieter.
A number of ETF managers also now offer Exchange Traded Funds based on the VIX which go up in price as volatility increases. Leading exponents include iPath Series B S&P 500 VIX Short Term Futures ETF and the ProShares VIX Short Term Futures ETF. There are others on the market but these look like the current market leaders.
Note however that the VIX can be incredibly volatile itself. But we think it’s a great way to trade volatility in the market as it picks up, then go short as things get quieter again.
