Since mid-February, volatility has once again exploded after a lull, with the CBOE Volatility Index (VIX), known as the “fear index”, running up from 13.35 to 36, nearly tripling in just 2 weeks, as stocks are on track for their most precipitous fall since 2008. The coronavirus is definitely a key catalyst that has put fear into markets, although coiled volatility or compression often leads to a dramatic selloff.
“The VIX follows some very specific patterns that show compression,” Henrich said last year on CNBC’s “Trading Nation.” “If you look back to, let’s say, the last few years, we’ve seen a large compression pattern from 2016 to 2017.”
“When that energy compresses too much, then we see these spikes,” the strategist said. “We have seen these spikes with quite a bit of regularity, but they always need some sort of trigger.”
Although this volatility can present significant investment risk, when correctly harnessed, it can also generate solid returns for shrewd investors.
According to Investopedia, “(VIX) detects market volatility and measures investor risk, by calculating the implied volatility (IV) in the prices of a basket of put and call options on the S&P 500 Index. A high VIX reading marks periods of higher stock market volatility, while low readings mark periods of lower volatility. Generally speaking, when the VIX rises, the S&P 500 drops, which typically signals a good time to buy stocks.”
Investors looking to use ETFs to trade the VIX over the short term can look at the iPath Series B S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX) which is up 8.45% on Thursday, or the ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY), which also advanced 7.98%, along with the CBOE Volatility Index. Potential investors should keep in mind that VIX-related exchange traded products track VIX futures and not the spot price.
The VIX is an index that’s also often referred to as Wall Street’s “fear gauge” for a reason. The VIX’s historical average is around 19.5, but it is currently trading above 30, which could be contributing to the manic gyrations investors are witnessing in markets this month, and meaning it may be getting a bit frothy short term soon.
Since the VIX typically rallies as stocks fall, the index is frequently used as a measure of how much investors will pay to buy insurance against potential stock-market falls. To give some idea of what the index looks like at extremes, the VIX peaked at 80.86 back in November of 2008, but reached an all-time low of 9.14 in November of 2017, as it hit an oversold level of complacency in the market, which coincided with a number of historical records for equity indices.
In the event that volatility does start to compress, investing in stocks once again using time-tested ETFs like the SPDR S&P 500 ETF Trust (SPY), the SPDR Dow Jones Industrial Average ETF (DIA), and the Invesco QQQ Trust (QQQ) is one simple way to play the long side.
For more market trends, visit ETF Trends.