What is an ETF? — Part 28: CBOE Volatility Index (VIX)
October 30th 2012 at 8:00am by Tom Lydon
Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 27: 130/30 Strategy]
The CBOE Volatility Index, or simply the “VIX,” is a widely observered indicator for investor sentiment in the stock market. Exchange traded products that track VIX futures allow investors to profit during rising volatility or hedge against short-term turns.
Launched in 2004, the VIX Index is a relatively new concept. The VIX tries to measure expected or implied volatility on large-capitalization U.S. stocks through options traded on the S&P 500 index. The CBOE Volatility Index is based on the prices of a weighted blend of call and put options. As options premiums rise, expectations on future volatility in the underlying S&P 500 index also rise.
The index is a popular tool for options and equity traders, and it has been widely used as a measure of market risk, acting as a key barometer of investor fear and confidence in the markets. Generally, a high VIX reflects the spiking investor fear in the markets, and a low VIX shows investor complacency in a calm market.
Basically, the VIX helps provide an overview of how volatile investors think the markets will be over the next 30 days. Historically, the VIX has hovered between 15 and 20. Anything below 20 generally corresponds with less fear in the market or greater complacency, whereas readings above 30 are typically associated with high volatility. For instance, during the height of the 2008 financial crisis, the VIX almost topped at 90.
Since the VIX acts on market fear, observers will notice that the VIX tends to show a negative correlation to the overall performance of the U.S. equities markets. As such, traders may utilize this contrarian investment tool to estimate market tops or bottoms on a short-term basis. However, high market volatility does not necessarily translate into a market bottoming out, although it does signal extreme duress in the markets.
During times of low volatility, the VIX will trade in a state of contango since the future is unknown and the higher prices will reflect greater potential volatility, whereas the VIX will trade in backwardation if the markets are currently experiencing high volatility since high levels of volatility will not last forever. As such, VIX-related funds tend to be much more profitable during times of high market volatility with the futures market undergoing backwardation. [Backwardation and Contango]
VIX exchange traded note options include:
- iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX)
- iPath S&P 500 VIX Mid-Term Futures ETN (NYSEArca: VXZ)
- iPath Inverse S&P 500 VIX Short-Term Futures ETN (NYSEArca: XXV)
- iPath Inverse S&P 500 VIX Short-Term Futures ETN II (NYSEArca: IVOP)
- iPath S&P 500 Dynamic VIX ETN (NYSEArca: XVZ)
- VelocityShares VIX Short-Term ETN (NYSEArca: VIIX)
- VelocityShares VIX Medium-Term ETN (NYSEArca: VIIZ)
- VelocityShares Daily Inverse VIX Short-Term ETN (NYSEArca: XIV)
- VelocityShares Daily 2x VIX Short-Term ETN (NYSEArca: TVIX)
- VelocityShares Daily Inverse VIX Medium-Term ETN (NYSEArca: ZIV)
- VelocityShares Daily 2x VIX Medium-Term ETN (NYSEArca: TVIZ)
- UBS E-TRACS Daily Long-Short VIX ETN (NYSEArca: XVIX)
ETF options include:
- ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY)
- ProShares Short VIX Short-Term Futures ETF (NYSEArca: SVXY)
- ProShares Ultra VIX Short-Term Futures ETF (NYSEArca: UVXY)
- ProShares VIX Mid-Term Futures ETF (NYSEArca: VIXM)
For past stories in this series, visit our “What is an ETF?” category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.