But for those who are more inclined to trade and speculate, ETFs that track the VIX can be a useful tool. When uncertainty and fear hits the market, stocks generally fall, and your portfolio could take a hit. But because of how they’re constructed, even the best volatility ETFs tend to decline in value over time, even if they do spike higher in times of intense volatility. Downside risk can be adequately hedged by buying put options, the price of which depends on market volatility. Astute investors tend to buy options when the VIX is relatively low and put premiums are cheap. Such protective puts will generally get expensive when the market is sliding; therefore, like insurance, it’s best to buy them when the need for such protection is not obvious (i.e. when investors perceive the risk of market downside to be low).

During its origin in 1993, VIX was calculated as a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options, when the derivatives market had limited activity and was in its growing stages. VIX values are calculated using the CBOE-traded standard SPX options, which expire on the third Friday of each month, and the weekly SPX options, which expire on all other Fridays. Only SPX options are considered whose expiry period lies within more than 23 days and less than 37 days. The second method, which the VIX uses, involves inferring its value as implied by options prices.

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• It tends to rise during times of market stress, making it an effective hedging tool for active traders.
• Large institutional investors hedge their portfolios using S&P 500 options to position themselves as winners whether the market goes up or down, and the VIX index follows these trades to gauge market volatility.
• 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.
• But remember, if your life is in danger, always call 911 or go to an emergency room right away.
• The Chicago Board Options Exchange Volatility Index, or VIX, is an index that gauges the volatility investors expect in the U.S. stock market.

Some exchange-traded securities let you speculate on implied volatility up to six months in the future, such as the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ), which invests in VIX futures with four- to seven-month maturities. The VIX, which was first introduced in 1993, is sometimes called the “fear index” because it can be used by traders and investors to gauge market sentiment and see how fearful, or uncertain, the market is. The VIX typically spikes during or in anticipation of a stock market correction. The CBOE Volatility Index (VIX) is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX). Because it is derived from the prices of SPX index options with near-term expiration dates, it generates a 30-day forward projection of volatility. Volatility, or how fast prices change, is often seen as a way to gauge market sentiment, and in particular the degree of fear among market participants.

About Volatility S&P 500 Index

Volatility is one of the primary factors that affect stock and index options’ prices and premiums. As the VIX is the most widely watched measure of broad market volatility, it has a substantial impact on option prices or premiums. A higher VIX means higher prices for options (i.e., more expensive option premiums) while a lower VIX means lower option prices or cheaper premiums. Such VIX-linked instruments allow pure volatility review the only investment guide you’ll ever need exposure and have created a new asset class.

Options are derivative instruments whose price depends upon the probability of a particular stock’s current price moving enough to reach a particular level (called the strike price or exercise price). In addition to being an index to measure volatility, traders can also trade VIX futures, options, and ETFs to hedge or speculate on volatility changes in the index. 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.

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Although the index can provide helpful information, investor sentiment isn’t always correct. In fact, the VIX tends to overestimate market volatility by about 4% to 5% on average, according to Fidelity. The VIX index tracks the tendency of the S&P 500 to move away from and then revert to the mean. When the stock markets appear relatively calm but the VIX index spikes higher, professionals are betting that prices on the S&P 500—and thereby the stock market as a whole—may be moving higher or lower in the near term. When the VIX moves lower, investors may view this as a sign the index is reverting to the mean, with the period of greater volatility soon to end. Perhaps the most straightforward way to invest in the VIX is with exchange-traded funds (ETFs) and exchange-traded notes (ETNs) based on VIX futures.

All such qualifying options should have valid nonzero bid and ask prices that represent the market perception of which options’ strike prices will be hit by the underlying stocks during the remaining time to expiry. The first method is based on historical volatility, using statistical calculations on previous prices over a specific time period. This process involves computing various statistical numbers, like mean (average), variance, and finally, the standard deviation on the historical price data sets. The index is more commonly known by its ticker symbol and is often referred to simply as “the VIX.” It was created by the CBOE Options Exchange and is maintained by how to write rfp for software CBOE Global Markets. It is an important index in the world of trading and investment because it provides a quantifiable measure of market risk and investors’ sentiments. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer.

Volatility is a statistical measure based on how much an asset’s price moves in either direction and is often used to measure the riskiness of an Cfd trading platform asset or security. But to understand how the Volatility Index works, it’s helpful to have a basic understanding of options trading. When you purchase options, you’re buying the right (but not the obligation) to buy or sell a stock at a specified date and price. In times of uncertainty, investors will pay a premium for what’s essentially a form of insurance. Higher options prices across the overall stock market indicate that investors expect heightened volatility.

It then started using a wider set of options based on the broader S&P 500 Index, an expansion that allows for a more accurate view of investors’ expectations of future market volatility. A methodology was adopted that remains in effect and is also used for calculating various other variants of the volatility index. But VIX-tracking funds are typically used by day traders and tend to be extraordinarily risky.

It tends to rise during times of market stress, making it an effective hedging tool for active traders. Though it can’t be invested in directly, you can purchase ETFs that track the VIX. When its level gets to 20 or higher, expectations are that volatility will be above normal over the coming weeks. That much is understood by most investors, but what exactly is volatility and how is it measured for the overall stock market? You may have seen references to something called the VIX, an index that measures volatility, during times of extreme financial stress. In August 2024, the VIX jumped above 60, a level not seen since the market meltdown in the initial stages of COVID-19 in March 2020, as worries grow about a possible recession.

Or they may take a position in a VIX-linked product for portfolio diversification or as a hedging strategy. Prices are weighted to gauge whether investors believe the S&P 500 index will be gaining ground or losing value over the near term. Bankrate.com is an independent, advertising-supported publisher and comparison service.

In finance, mean reversion is a key principle that suggests asset prices generally remain close to their long-term averages. If prices gain a great deal very quickly, or fall very far, very rapidly, the principle of mean reversion suggests they should snap back to their long-term average before long. Investing in the VIX directly is not possible, but you can purchase ETFs that track the index as a way to speculate on future changes in the VIX or as a tool for hedging. This isn’t something that will make sense for most investors who are working to meet a long-term goal such as saving for retirement.