What is the VIX and why should you care? The CBOE Volatility Index (VIX) is a measure of the expected near-term price swings in the S&P 500 stock index (SPX). The VIX value is derived from the prices that market participants are willing to pay for options that expire roughly 30 days in the future. Typically, movements upward in VIX correspond to movements downward in broad market averages, since price volatility is usually associated with some “problem” cropping up. During market turbulence, the VIX can shoot up very high, very fast, with a percentage of change far higher than for stock prices.
The VIX is know as the “fear gauge,” since it provides a standardized measure of market volatility expectations. It is thus a number that conveys significant information about the attitudes of market participants. Also, it provides opportunities for investors to make (or lose) a lot of money quickly. You cannot invest directly in the VIX (it is just a calculated number), but you can buy/sell VIX futures and options on those futures. Also, there are convenient funds that buy (e.g., VXX) or short (e.g., SVIX) the VIX futures. Because the VIX makes much bigger percentage moves than stock themselves, you can make a killing with a modest investment, providing you get the timing right.
For instance, over the past twelve months, the SPY S&P 500 fund has gone up by about 18%, so $10,000 would have gone to $11,800. That’s pretty nice. But in that same period, SVIX went up by 143%, which would take $10,000 to $24,300 (see below). (Nerdy notes: (a) SVIX shorts the VIX, so it generally goes up when VIX goes down, i.e., when stocks go up. (b) There is another factor with SVIX called the monthly roll, when tends to make it rise something like 2-4% a month on average. This monthly roll factor is layered on top of the rise and fall in SVIX value based on VIX level. So even if VIX is flat, SVIX may go up something like 30% in a year. )
SVIX and SPY share prices for the past year. Source: Seeking Alpha
Of course, the price swings on SVIX cut both ways. It is down hugely from its highs a month ago, as VIX has increased from roughly 14 to 20. You can go even more crazy by purchasing/shorting VIX-related funds like UVXY that are leveraged at more than 1.0X.
Even you were even more clever, you could have made even more, much more, by working VIX options. Also, if you just want to hedge your stock portfolio against sudden drops, it is often more economical to do that by buying (call) options on the VIX, than by buying (put) options on the stocks (e.g., SPX, SPY) themselves.
During long periods of market stability, the VIX tends to slowly drift downward, to an asymptote somewhere in the 12-13 range. For example, in the five-year plot below, VIX spend much of 2019 around 13, then shot up over 80 within a month when the scope of the COVID pandemic became apparent. It then drifted downwards (with many spikes along the way, especially during the big bear market of 2022), getting down to around 14 for much of June-September of this year.
VIX Level for past five years. Source: Seeking Alpha.
It is notable for VIX to be this low, considering a number of serious current market concerns (the relatively high valuation of the stock market, stubborn inflation, hawkish fed, gridlock in Washington, etc.). And now with serious conflict in the Middle East resulting from the massive attacks on Israeli civilians, the VIX has so far only risen to 20.
A number of market commentators have noted the seemingly anomalously low level of the VIX, and have proffered various explanations. They observe that macroeconomic outlook continues to look probably OK. They also point to some fundamental changes in the stock market operations. One factor is the rise of zero-day options, very short-term stock options that expire within one day. More of the speculative action has gone to those options, with proportionately less in the month-out options that drive the VIX.
Also, the stock exchanges have implemented various “circuit-breakers,” which halt trading for specified time periods, if swings in stock prices get out of hand. This gives participants a chance to cool off and recalibrate, and not have to make frantic, quick (possibly losing) trades in order to protect themselves. Here is a diagram illustrating these circuit breakers, which are triggered by big moves in the broad S&P 500 stock average:
Source: Seeking Alpha, article by Christopher Robb
There are also Limit Up/Limit Down (LULD) rules in place that temporarily halt trading in an individual stock if its price swings exceed some designated band. is designed to stop excess volatility in a single stock. With these protective circuit-breakers in place, market participants seem less worried about huge price swings coming at them, and hence may feel less of a need to “buy insurance” by purchasing options. This suppression of stock option prices in turn leads to a lower calculated VIX.
As usual, this blog post is not meant to be advice to buy or sell any security. (And seriously, the “never bet more than you can afford to lose” rule applies doubly with the high-volatility products discussed here).
