CBOE Volatility S&P 500 Index (VIX) spelled out with three male figurines in front

Understanding the VIX and Incorporating It Into Our Perspective

By:Ryan Sullivan

On January 4th, 2022, the CBOE Volatility S&P 500 Index (VIX) logged its low for the year at 16.36 and then spent the next 21 days (about 3 weeks) rallying to this year's high of 38.94 on January 24th, 2022. Price action since then has remained between these price extremes for the year. The VIX’s January 24th, 2022 peak marks a new high since October 20th, 2020, 451 days (about 64 weeks).

Technically speaking, the VIX has recorded higher highs and higher lows since February 9th, 2022, followed by lower highs since February 24th, 2022. Inside price action since February 25th, 2022, suggests an inflection point for the VIX. A breakout above 37.79 will likely show us more sustained high volatility in the near term. A breakout below 26.93 will likely show us the opposite, a continued decrease in volatility in the near term.

What is the VIX?

The VIX is an index that helps us understand the expected velocity of price movement for approximately the next thirty days, derived from short-term S&P 500 (SPX) index options. Since options are derivatives with a price that is based on the expected move of the underlying, they are used to calculate volatility. Furthermore, since options are time sensitive, they provide the VIX volatility calculation with a time variable that provides us with forward-looking expectations.

Interestingly, the VIX does have a mean reverting quality. The mean price of the VIX since May of 1990 is 19.48. Since we know the SPX index traded before 1990 and continues to trade through the present day, there has always been a forward-looking expectation that the SPX index price will move. As a result, the VIX has never fallen to zero. In fact, the CBOE Volatility S&P 500 Index (VIX) has never fallen below 8.

Fig. 1: A VIX index distribution graph that shows where price has been recorded since 1990.

A VIX index distribution graph that shows where price is has been recorded since 1990.

If we base our assumptions about the value of the VIX index on historical volatility calculations, we can assume that the higher or lower the VIX goes the more quickly it will want to return to its mean. We can interpret this phenomenon by understanding that the market wants to discover the most efficient market price and transact at that level if it can. The market will resist extreme movement until it no longer can, which leads to a breakout in price and a spike in volatility.

How to trade the VIX

The VIX index led to the creation of trading instruments that provide traders with direct exposure to volatility. The VIX futures contract began trading in March of 2004 and options on VIX futures began trading in February of 2006. The popularity of volatility-based trading has sprouted a variety of volatility-based products that can be used by institutions and retail traders alike to invest, hedge, and speculate on the volatility of nearly every equity that the market has to offer.

Understanding volatility indexes and their tradable products allows us as traders to gain insight into the market and make assumptions about the sentiment of market participants. It is then up to us as traders to interpret that information and incorporate it into our perspective. Our perspective, with volatility in mind, has the potential to allow us to make better predictions about where we think the market might move to next. Thereby allowing us to make more accurate trades and be more efficient traders.

To trade VIX futures or other volatility products, open an account on tastytrade.

CBOE Crude Oil Volatility Index (OVX)

A specific example of a volatility index and its relationship with a tradeable underlying is the CBOE Crude Oil Volatility Index (OVX). We can reference the OVX index to gain direct insight into Crude Oil Futures (/CL). The higher the OVX price moves, the more velocity we can expect from the movements of the Crude Oil Futures price in the near term.

This relationship is certainly true today as we see the OVX moving above 70 this morning with strength as Crude Oil Futures (/CL) contracts continue to rally through the low 100s. If the OVX index remains high, we can expect high velocity moves in /CL in the near term.

tastytrade, Inc. and tastylive, Inc. are separate but affiliated companies.

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastylive content is created, produced, and provided solely by tastylive, Inc. (“tastylive”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, digital asset, other product, transaction, or investment strategy is suitable for any person. Trading securities, futures products, and digital assets involve risk and may result in a loss greater than the original amount invested. tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastylive is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer.  Options, futures, and futures options are not suitable for all investors.  Prior to trading securities, options, futures, or futures options, please read the applicable risk disclosures, including, but not limited to, the Characteristics and Risks of Standardized Options Disclosure and the Futures and Exchange-Traded Options Risk Disclosure found on tastytrade.com/disclosures.

tastytrade, Inc. ("tastytrade”) is a registered broker-dealer and member of FINRA, NFA, and SIPC. tastytrade was previously known as tastyworks, Inc. (“tastyworks”). tastytrade offers self-directed brokerage accounts to its customers. tastytrade does not give financial or trading advice, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastytrade’s systems, services or products. tastytrade is a wholly-owned subsidiary of tastylive, Inc.

tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. tastytrade and Marketing Agent are separate entities with their own products and services. tastylive is the parent company of tastytrade.

tastycrypto is provided solely by tasty Software Solutions, LLC. tasty Software Solutions, LLC is a separate but affiliate company of tastylive, Inc. Neither tastylive nor any of its affiliates are responsible for the products or services provided by tasty Software Solutions, LLC. Cryptocurrency trading is not suitable for all investors due to the number of risks involved. The value of any cryptocurrency, including digital assets pegged to fiat currency, commodities, or any other asset, may go to zero.

© copyright 2013 - 2024 tastylive, Inc. All Rights Reserved.  Applicable portions of the Terms of Use on tastylive.com apply.  Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastylive’s podcasts as necessary to view for personal use. tastylive was previously known as tastytrade, Inc. tastylive is a trademark/servicemark owned by tastylive, Inc.