What is the Volatility Index (VIX)?
The VIX is a real-time volatility index, created by the Chicago Board Options Exchange (CBOE). It was the first benchmark to quantify market expectations of volatility. But the index is forward looking, which means that it only shows the implied volatility of the S&P 500 (SPX) for the next 30 days.
Please note: the values in this chart should be viewed as representations only and should not be taken as accurate VIX Index figures for the stipulated time periods.
The VIX is calculated using the prices of SPX index options and is expressed as a percentage. If the VIX value increases, it is likely that the S&P 500 is falling, and if the VIX value declines, then the S&P 500 is likely to be experiencing stability.
What does the VIX measure?
While the VIX only measures S&P 500 volatility, it is commonly used as a benchmark for the entire US stock market. The price of options is considered a good measure of volatility as if something concerns the market, traders and investors tend to start buying options, which causes prices to rise. This is why the VIX is also known as the fear index, as it measures the level of market fear and stress.
The current volatility cannot be known ahead of time, so the VIX is best used in tandem with historical analysis of support and resistance lines.
Why trade the VIX?
VIX-linked instruments have a strong negative correlation with the stock market, which has made them a popular choice among traders and investors for diversification and hedging, as well as pure speculation.
By taking a position on the VIX, you could potentially balance out other stock positions in your portfolio and hedge your market exposure.
Let’s say that you have a long position on the stock of a US company that was a constituent of the S&P 500. Although you believe it has long-term prospects, you want to reduce your exposure to some short-term volatility. You decide to open a position to buy the VIX with the expectation that volatility is going to increase. By doing so, you might balance out these positions.
If you were wrong, and volatility didn’t increase, your losses to your VIX position could be mitigated by gains to your existing trade.
Research how the VIX works
The VIX works by tracking the underlying price of S&P 500 options – not the stock market itself. Below you’ll learn what S&P 500 options are, how the VIX is calculated and what its value means.
Learn about VIX and S&P 500 options
The VIX measures S&P 500 options, which are options contracts that take their prices from Standard & Poor’s 500 – a capitalisation weighted index of 500 stocks in the US. They give the trader the right, but not the obligation, to trade the S&P 500 at a set price, before a set date of expiry.
A call option would give you right to buy the S&P 500 at a specific price, while a put option would give you the right to sell the S&P 500 at a specific price. The price that you choose to buy or sell the underlying market is known as the strike price.
Learn how to calculate the VIX
The VIX is calculated in real time using the live prices of S&P 500 options – this includes standard CBOE SPX options, which expire on the third Friday of every month, and weekly CBOE SPX options that expire every Friday. To be considered for the VIX index, an option must have an expiry date between 23 and 37 days.
The calculation of the VIX involves extremely complex mathematics, though it isn’t necessary for every trader to understand this in order to trade the index. However, the basic theory of the calculation is that by combining the weighted prices of multiple S&P 500 put and call options over a wide range of strike prices, we can gain insight into what prices traders are willing to buy and sell the S&P 500 at. These final values will estimate the future volatility of the S&P 500.
The options that qualify for inclusion will be at the money so that they show the general market perception of which strike prices are going to be hit before expiry. This then indicates the wider market sentiment surrounding the direction of the market price.
Understanding VIX values
Volatility is a measure of the movement of an asset’s price, rather than the price of the asset. When you trade volatility, you aren’t focused on the direction of change, but how much and how frequently the market has moved. This is why VIX values are quoted as percentage points.
For the past several years, if the VIX was trading below 20 then the market was considered to be in a period of stability, while levels of 30 or more indicated high volatility. Still, remember, trading volatility is not trading a market downturn, as it is possible for the market to decline but volatility remain low.
There is a strong negative correlation between the VIX and stock market returns. If the VIX moves up, it is likely that the S&P 500 is falling in price. If the volatility index declines, then the S&P 500 is likely to be experiencing stability. The VIX is thought to predict tops and bottoms in the SPX. There is even a mantra that states: ‘when the VIX is high, it’s time to buy. When the VIX is low, look out below’.
When you trade the VIX, you aren’t trading an asset directly because there is no physical asset to buy or sell. Instead, with us, you can use spread bets and CFDs to take a position on the movement of the VIX, as well as VIX futures and exchange traded funds (ETFs).
On our side, we price our cash Volatility Index (VIX) contracts in a different way to the rest of our cash index markets. Rather than aiming to replicate the underlying index price, we follow the method used to derive our undated commodity prices. This means that there is a difference between our undated price and the underlying index price on these markets.
Choose whether to spread bet or trade CFDs
Spread betting on the Volatility Index
Spread betting on the Volatility Index involves making a bet on the direction that the levels of volatility are headed in. The further the Volatility Index moves in the direction that you have predicted, the more you would profit, and the further it moves against your position, the more you would lose. Your profit or loss is determined by the size of your bet per point of movement.
Spread betting is a form of leveraged trading, meaning you would put down a small deposit (called margin) to open a larger position. However, leveraged trading is not without risk, as your profits or losses can easily outweigh you deposit. This is because both are calculated on total position size, not your margin amount.
A significant feature of spread betting the Volatility Index is that all of your profits are tax free.2
CFD trading on the Volatility Index
When you trade the Volatility Index with CFDs, you are agreeing to exchange the difference in price from when you opened the position to when you close it. Like with spread betting, the more that the Volatility Index moves in the direction that you have predicted, the more you would profit and the more it moves against you, the more you would lose.
Unlike spread betting, CFDs are liable for capital gains tax, but you can offset your losses against profits elsewhere for tax purposes.2
Like spread betting, CFDs are leveraged trades, so your losses or profits could outweigh your initial deposit amount.
Decide whether to go long or short on the VIX
When you trade the VIX, there are two basic positions that you can take: long or short. It is important to remember that volatility traders aren’t interested in whether the price of the S&P 500 is going to rise or fall, as they can capitalise on both – they’re instead looking at whether the market is volatile.
Going long on the VIX
The position you decide to take will depend on your expectation of volatility levels. Traders who go long on the VIX are those who believe that volatility is going to increase and so the VIX will rise. Going long on the VIX is a popular position in times of financial instability, when there is a lot of stress and uncertainty in the market.
For example, if you thought that the S&P 500 was going to experience a significant and rapid decline following a political announcement, you might take a long view of volatility. You could do this by opening a position to buy the VIX.
If there was volatility, your prediction would have been right, and you could take a profit. However, if you had taken a long position and there was no volatility on the market, your position would have suffered a loss.
Going short on the VIX
When you take a short position on the VIX, you’re essentially expecting that the S&P 500 is going to rise in value. Short-selling volatility is particularly popular when interest rates are low, there’s reasonable economic growth and low volatility across financial markets.
Let’s say that the combination of low volatility and high economic growth had led to steady growth in the S&P 500 constituent’s share prices. You might decide to short volatility with the expectation that the stock market will keep rising and volatility will remain low.
If the S&P 500 does rise, then the VIX is likely to move to a lower level, and you could take a profit. However, shorting volatility is inherently risky, as there is the potential for unlimited loss if volatility spikes.
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What does the VIX measure?
The VIX measures the implied volatility of the S&P 500 (SPX), based on the price of SPX options. It is calculated and published by the Chicago Board Options Exchange (CBOE). As the S&P 500 is widely regarded as a barometer for US stock market health, the VIX is thought to measure implied volatility across US stock indices.
What does it mean when the VIX is low?
When the VIX is low, it means there is less market fear, more stability and long-term growth. The VIX typically has a negative correlation with the S&P 500, so when the VIX is low, the S&P 500 is usually experiencing a rise in price.
What does it mean when the VIX is up?
When the VIX is up, it means that there are significant and rapid price fluctuations on the S&P 500. The VIX typically has a negative correlation with the S&P 500, so in periods of market stress, the VIX increases.
Why is the VIX called 'the fear index'?
The VIX is sometimes referred to as ‘the fear index’ because it negatively correlates closely with the S&P 500. Often, times of elevated uncertainty mean higher values on the VIX. Conversely, more certain times with less macroeconomic volatility mean a ‘flatter’ VIX with lower values.
What is considered a high VIX index?
A high VIX index is levels of 30 or more, while the VIX trading below 20 is considered to be in a period of stability
What is the difference between VXX and VIX?
VXX is a type of product, specifically an Exchange Traded Note (ETN), used to trade volatility on the S&P 500, while VIX is an index measuring volatility. The VXX trades S&P movements as measured by the VIX.
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1 We price our Volatility Index (VIX) contracts in a different way to the rest of our cash index markets. Rather than aiming to replicate the underlying index price, we follow the method used to derive our undated commodity prices. This means that there is a difference between our undated price and the underlying index price on these markets. Funding is also calculated in line with the undated commodity method. Please see our overnight funding page for more details.
2 Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.