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.