VIX – The Fear Index

We are at a point that, for the past 2.5 years, I though was improbable.  The Fear Index, or CBOE Volatility Index (VIX), closed today at 11.68.  The lowest it has been this year is  11.39, and the lowest it has ever been is 9.31, way back on December 22, 1993, in the latter parts of a bull market that began in October of 1990 and ended in February 1994.


By April of 1994, the S&P 500 was down over -6.8% from the December 1993 levels, with $VIX rising to 23.87, or 155.37%.  The S&P 500 traded in a broad range until February 1995, when it broke resistance and continued a rally that really did not take a significant breather until July of 1998 and eventually ended with the bursting of the dotcom bubble, which began in March of 2000.

What is the CBOE Volatility Index?

As per the Chicago Board of Options Exchange website:

The CBOE Volatility Index® (VIX® Index®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, the VIX Index has been considered by many to be the world’s premier barometer of investor sentiment and market volatility. Several investors expressed interest in trading instruments related to the market’s expectation of future volatility, and so VX futures were introduced in 2004, and VIX options were introduced in 2006.

Options and futures on volatility indexes are available for investors who wish to explore the use of instruments that might have the potential to diversify portfolios in times of market stress.

Please visit the links on this page to explore how you could use VIX-related products in the management of your investment portfolio.

As per INVESTOPEDIA, it is:

VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking, is calculated from both calls and puts, and is a widely used measure of market risk, often referred to as the “investor fear gauge.”

BREAKING DOWN ‘VIX – CBOE Volatility Index’

The CBOE designed the VIX to create various volatility products. Following the CBOE’s lead, two other variations of volatility indexes have since been created: the VXN, which tracks the NASDAQ 100; and the VXD, which tracks the Dow Jones Industrial Average (DJIA).

The VIX, however, was the first successful attempt at creating and implementing a volatility index. Introduced in 1993, it was originally a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, in 2004, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors’ expectations on future market volatility. VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.

How the VIX’s Value Is Established

The VIX is a computed index, much like the S&P 500 itself, although it is not derived based on stock prices. Instead, it uses the price of options on the S&P 500, and then estimates how volatile those options will be between the current date and the option’s expiration date. The CBOE combines the price of multiple options and derives an aggregate value of volatility, which the index tracks.

While there is not a way to directly trade the VIX, the CBOE does offer VIX options, which have a value based on VIX futures and not the VIX itself. Additionally, there are 24 other volatility exchange-traded products (ETPs) for the VIX, bringing the total number to 25.

An Example of the VIX

Movements of the VIX are largely dependent on market reactions. For example, on June 13, 2016, the VIX surged by more than 23%, closing at a high of 20.97, which represented its highest level in over three months. The spike in the VIX came about due to a global sell-off of U.S. equities. This means global investors saw uncertainty in the market and decided to take gains or realize losses, which caused a higher aggregate equity supply and lower demand, increasing market volatility.

Read more: VIX (CBOE Volatility Index) Definition | Investopedia
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As per Carlos (me), it is a measure of the volatility of SPX options.  Theoretically, large moves in Implied Volatility of options can manifest themselves in a higher VIX value, whether people are feverishly buying calls in a bull market that has already left the station, or frantically buying protection, or puts, from a market crash.

Why is this important?

Rarely do we find markets that completely appreciate the possibility of major market swings.  Had you been a trader of VIX call options in August and September of 2015, you could have realized gains of close to 2000%.  I did not foresee the magnitude of gains, but it was one of the trades that I practically begged my treasury department to do, to no avail.  The VIX rose from 12.12 on July 30th to 40.74 on the 24th of August, and the S&P 500 fell over -11%.   These dramatic changes in equity index prices affect the value of derivatives of those indices almost exponentially.

Well, this idea of loading up on VIX, whether it be futures or options, is no longer a secret, but it is still perplexing in its ridiculousness.  The following chart, thanks to @Hedgopia, indicates that hedge funds are SHORT a record amount of VIX futures, when the VIX is close to historically low levels.


As goofy as this seems, it still merits analysis.  It make sense that hedge funds would load up on VIX shorts when they expect volatility to drop in the market, which is confirmation of a trend or a relaxation of anxiety over future market returns.  The S&P 500 is breaking resistance and  churning higher, from historically high levels no less.

index comparo 81116.png

Just think about it: Hedgefunds have loaded up on VIX shorts in order to profit from a further fall in the VIX.  To what level?  To it’s all-time low of 9.31?  Why didn’t they load up after the Brexit vote?  VIX was above 25!

At this level, a VIX short is an expression of a very bullish view of the stock market, though profiting from a VIX short seems limited and it makes more sense to by some longer dated out of the money calls, if not for the relatively high implied volatilities in both calls and puts.  Today, the implied volatility of calls are around 65-75%, whereas the puts are around 60-70%.  Expensive?  Yes.  Still, a VIX short near all-time lows is like squeezing juice from an already dessicated fruit.  Logically, because VIX put buyers are  betting on the current trend to remain in equity markets.

Being the skeptic that I am, VIX at such low levels is an indication of complacency in the S&P 500 (in spite of the implied volatility) and, just as in August of 2015, something is either too good or too wrong.  Some might say that they are one and the same.


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