The CBOE Volatility Index, or more commonly known as the “VIX”, tracks the market’s volatility. VIX-related exchange traded products offer a way to play investor sentiment, on the market’s so-called “fear gauge.”

First introduced in 1993, the VIX has become a popular gauge of investor sentiment and volatility within the marketplace. The index measures expected volatility over the coming 30-days as shown through near-term options traded on the S&P 500 index. It should be noted that the VIX represents price volatility implied by the options market and not the real or historical volatility of the index.  As options premiums rise, expectations on future volatility in the underlying S&P 500 index rise.

In short, the VIX is a calculation based on how volatile investors believe the markets will be over the next 30 days.

Interpreting the VIX

The index is a popular trading tool for options and equity traders, and it has been widely used as a measure of market risk.  It is a key barometer of investor fear and confidence in the markets.  Generally, a high VIX reflects heightened investor fear in the markets and a low VIX shows investor complacency. [ETF Options Continue to Flash Higher Volatility.]

Historical data shows bull markets have generally corresponded with long-term lows in the VIX, usually under the 20 point level. Since the inception of the index, the VIX has quickly spiked upward during each market downturn, providing investors with a signal that a market bottom was nearing.  When the VIX reads above 30, investor fears are mounting and the index is in a bullish run. [Are VIX ETFs Understating Market Risks?]

Investors may utilize this contrarian investment tool to estimate market tops or bottoms on a short-term basis.

Putting the VIX to Work

VIX futures began trading in 2004, and with the advent of futures-based ETFs and ETNs, the average retail investor is now able to gain access to VIX options.

The VIX can be a useful trading tool to help provide opportunities for hedging, speculation and even portfolio diversification. Due to the nature of its construction, the VIX has a negative correlation with the S&P 500.

The first VIX products were ETNs that provide short-term traders exposure for hedging equity positions or speculating on spikes in stocks.  The ETNs don’t actually track the VIX index itself, they track a basket of rolling volatility futures. As a result, there may be a noticeable disparity between futures-based VIX ETPs and the spot price of the VIX.

Holding the ETNs for the long-term may lose some of its performance do to the contango in the VIX futures market.  Contango is when contracts are rolled and the long-term futures are more expensive than near month expirations translating to higher “roll yields.”

The number of VIX products has exploded in recent years.  The two ETF options track mid-and short-term VIX futures: ProShares VIX Short-Term Futures (NYSEArca: VIXY) and ProShares VIX Mid-Term Futures (NYSEArca: VIXM).  There are also a number of ETNs through which investors can get their exposure including:

  • iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX)
  • iPath S&P 500 VIX Mid-Term Futures ETN (NYSEArca: VXZ)
  • VelocityShares Daily Inverse VIX Short-Term ETN (NYSEArca: XIV)
  • VelocityShares Daily Inverse VIX Medium-Term ETN (NYSEArca: ZIV)
  • UBS E-TRACS Daily Long-Short VIX ETN (NYSEArca: XVIX)

Additionally, investors may play on the added exposure in leveraged ETN options:

  • VelocityShares Daily 2x VIX Short-Term ETN (NYSEArca: TVIX)
  • Daily 2X VIX Medium-Term ETN (NYSEArca: TVIZ)

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