CBOE Volatility Index, commonly known as VIXAnd It is one of the most popular metrics in the financial market.
Also known as fear scaleThe index is designed to provide More information about the expected volatility of the S&P 500 Index in the next 30 days.
In this article, we’ll look at what the VIX index is and how to use it Basic sentiment analysis tool in daily trading.
What is the VIX Index?
The VIX Index is a sentiment analysis tool that has been Created by Cboe and Goldman Sachs To measure the potential range of movement in the US stock market. Seems to see if the stock market will move above and below the current level.
Probably Collect this data on the broad US stock market. However, the VIX considers the S&P 500, which is made up of the 500 largest companies in the United States.
Therefore, when the VIX risesThis means that Investors expect more volatility. When it drops, it is usually a sign that volatility has dried up.
the The VIX is not designed to be a tradable asset. Instead, it was created to provide investors and traders confidence sentiment about the market So they can put their assets.
However, derivatives that track the VIX index have recently appeared, making it a tradable financial asset.
Related “ How to perform sentiment analysis
How is the VIX index calculated?
The VIX index is Calculated given the implied volatility of the S&P 500. As mentioned, the S&P 500 is The most ideal indicator Because it is made up of about 80% of all businesses in the United States.
VIX uses the options market. For starters, options refer to trades that people make based on where they expect to trade an asset in the future. Call option It gives you the right to a cash settlement if the price is higher than it is.
Sell option, on the other hand, gives you the right to a cash settlement if the price is below the current level. Options differ from futures because their holders have no obligation to buy or sell an asset.
The VIX measures implied volatility Given the weighted average price of these trades and call options. Also, the VIX uses the options market, rather than spot prices because these options reflect the implied volatility that buyers and sellers expect in the market.
How do we interpret the VIX index?
The interpretation of the VIX index tends to depend on many factors. However, the general opinion is that the index rises when there are large fluctuations. When the index is going down, it is a sign that volatility is going down.
A good example of this is what happened At the beginning of the Covid-19 pandemic. As shown below, the index rose sharply to a high of $85.63. It was the highest level since 2009.
This chart also shows that the VIX jumped to a high of $89.71 during the Global Financial Crisis (GFC). At the time, the market was very volatile as the likelihood of bank failures in the US increased in the aftermath of the collapse of Lehman Brothers.
Standard & Poor’s Worldwidea giant financial data provider Create a good outline to simplify the explanation of the VIX index. Between 0 and 15, it means that volatility is low. Between 15 and 20, it indicates that there are moderate or normal market conditions.
Between 20 and 25, the VIX usually shows volatility with moderate volatility. In most cases, this situation indicates a growing concern in the market. Between 25 and 30 is a sign that volatility is rising. Finally, above 30, it is a sign that volatility is very high.
Use it as a leading indicator
The second most important method you can use in the market is Use it as a leading indicator.
A leading indicator is a tool that tells you what to expect. a VIX height It is usually an indication that there may be volatility in the coming days. So, if you like trading in volatile markets, then this is an indication that you will apply your strategy.
If you don’t like swings, a VIX retreat It is an indication that there will not be much action in the future.
However, not all lagging and leading indicators are always accurate. There are times when the VIX sends the wrong signal.
Therefore, it is important for you to apply other indicators in the decision-making process.
How to use the VIX to estimate the future of the S&P 500
It is possible to use the VIX index for Estimating the future performance of the S&P 500 index. And when you can predict the S&P 500, it is possible to estimate the performance of the NASDAQ 100 and the Dow Jones because both have closes. relationship one another.
To make this calculation, we’ll use the S&P 500 Index value of $4,105 and the VIX value of 18.4.
The first stage is where you are Convert the value of the VIX index to a percentage. In this case, the percentage is 18.4%. In the next step, you should Divide the annual percentage of rot squared by 12 for VIX. The formula below shows how this is done:
The third stage is where you are Multiply that number with the S&P 500 index number. This is it:
Finally, you Construction of the upper and lower floors from the index using these numbers. You can do this by adding or subtracting the number from the index.
|Upper level = 4105 + 217.9 = 4322.9 dollars|
|The lowest level = 3550 -217.9 = 3887.1 dollars|
How to trade or invest in the VIX
As mentioned, the VIX cannot be traded directly. instead of, Traders can trade index-tracked derivatives. Three of the most popular derivatives are CFDs, ETFs, and ETFs.
a CFD It is a financial product Tracks the price of a financial asset. Holders of these products do not have the same origin.
that ETFOn the other hand, it is a financial asset looks like an arrow. they Created by index funds Then companies like Vanguard and Schwab offered it. These ETFs seek to replicate the asset’s return by purchasing their futures contracts.
that Note traded on the stock exchangeon the other hand, is a type of debt that provides a return on a benchmark.
Traders can buy or sell the VIX using these financial instruments. Going long means buying instruments linked to the VIX and expecting the price to continue rising.
On the other hand, to sell means to sell the index and expect the price to continue declining.
What drives the VIX index?
There are many factors driving the VIX index. As mentioned, the index is Affected by options positions linked to the S&P 500 index.
Therefore, the most important index drivers are:
- Market sentiment – When investors are afraid or unsure, they may increase their demand for put options causing the VIX to rise.
- earnings Actual earnings may or may not match market expectations. A better-than-expected earnings report may increase investor confidence, causing lower volatility and, in turn, a decline in the VIX. The opposite can also happen.
- Supply and demand for options – If there is an increase in demand for options or option prices are extreme, this could indicate an increase in expectations of higher volatility, causing the VIX to rise.
- Federal Reserve forecasts Sudden changes in interest rates often lead to higher levels of market volatility.
- Geopolitical issues
- Goods’ prices
Among other things.
In this article, we have looked at what the VIX index is and how it is calculated. Also, we’ve evaluated some of the best ways to trade an index and the differences between ETFs and ETFs.
Most investors and traders use the index to predict where stocks and other assets will move in the future.