CBOE VIX : An Indicator of Market Stress Level

The CBOE VIX or VIX is short for the Chicago Board Options Exchange Volatility Index, which is a forecast of the market's expectation of volatility over the next 30 days. It is constructed using the implied volatilities of a range of S&P 500 index options. In addition to the VIX, there are two other variations of volatility indexes: whereas the VIX tracks the S&P 500, the VXN tracks the NASDAQ 100 and the VXD tracks the Dow Jones Industrial Average.

A comparison of VIX price action with that of the market can indicate future market direction. The more VIX increases in value, the more panic there is in the market. The more VIX decreases in value, the more complacency there is in the market. Thus, this measurement can be used as an indicator of market stress level. It can also be used as a contrarian indicator. Prolonged extremely low VIX readings (25 or less) indicate a high degree of complacency and are interpreted as bearish. Conversely, extremely high readings (>30), especially if they persist for a while, indicate a high degree fear, or even panic, among options traders, and are regarded as bullish. High VIX readings usually occur after an extended or sharp decline and the then-current sentiment is still quite bearish.



Yes, you can trade options on the VIX. When the CBOE created the VIX they made market volatility into a commodity You can even apply safe-options trading techniques to the VIX. For example, we might consider selling very deep out-of-the-money puts on the VIX immediately after the overall market has taken a sudden drop downward, and put premiums are inflated. Keep in mind that these options are cash-settled, European-style, and settle the third Wednesday of every month. For additional details see the CBOE website.



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