CBOE Volatility Index Review: How to Use the Vix in the Market
In 2018, major publications like CNBC reported about a trader they nicknamed as 50-Cent. At the time, the market had just experienced increased volatility as the US president started battling China.
Surprisingly, as most people in the market lost a substantial amount of money, 50-Cent made more than $400 million.
He made this money because he was betting on volatility.
In Wall Street, volatility can work for or against you. If you are a skilled trader, volatility could be your friend. The CBOE volatility index is the most common tools used to measure volatility.
In this article, we will look at the CBOE volatility index and how it works.
What is the CBOE Volatility Index?
The Chicago Board of Options Exchange (CBOE) is the biggest options-related exchanges in the world. The company, which is publicly-traded is worth more than $13 billion.
Some of its best-known products are related to volatility. The CBOE volatility index, also known as the VIX is the gold-standard when it comes to volatility.
The VIX was developed in 1992 when the company hired Bob Whaley, who had previously written a lot about volatility. The original index used options provided by stocks.
In 2002, CBOE partnered with Goldman Sachs to develop the VIX index that is in use today.
The idea was simple: compile data in the option market for all companies in the S&P 500 and then provide an average.
Example of How VIX Index Works
To starters, options is a way of trading that uses future contracts.
For example, as a trader, you can look at the stock price of a company like Apple, which is trading at $100. You can then believe that the stock will go up to $110 in the next 30 days.
You can then buy the stock and wait for it to move upwards. Alternatively, you can use futures contracts.
In this case, you can buy a call option. This option gives you a right to buy the stock while a put option gives you a right to sell. The VIX index uses the call and put options of companies in the S&P 500 to determine whether there is volatility or not.
How to Use the VIX Index in the Market
There are several ways you can use the VIX index.
First, you can trade the VIX itself. Many online brokers provide the VIX as a tradable instrument. In this case, you can buy the VIX if you believe that the volatility is set to increase. You can also short the VIX if you believe that the price will drop.
The second most important way you can use it in the market is to use it as a leading indicator.
A leading indicator is a tool that tells you what to expect. A rising VIX is usually an indicator that there could be volatility in the coming days. Therefore, if you like trading in volatile markets, this is an indicator that you will apply your strategy.
If you dislike volatility, a declining VIX is an indicator that there will be no much actions ahead.
However, not all lagging and leading indicators are always accurate. There are times when the VIX will send the wrong signal.
Therefore, it is important for you to apply other indicators in your decision-making.