Everyone knows that financial markets are unpredictable. Still, there are tools investors use to make general observations about how stock values will move. One of the most useful is the VIX, the ticker symbol for the Chicago Board Options Exchange’s (CBOE) Volatility Index.
The VIX, also known as Wall Street’s “fear index,” was launched in 1993 by the CBOE as a way to measure expected market volatility. In providing a 30-day forward look at projected volatility, VIX options enable market participants to hedge portfolio volatility risk based on a view of the future direction or movement of volatility.
The VIX works by tracking S&P 500 Index options being bought and sold. Options are tradable contracts typically used by traders to speculate on higher or lower future stock prices. By looking at the options trades, the VIX gauges the level of fear on Wall Street and assigns that a number in the range of one to 100. The VIX is negatively correlated to the S&P; it tends to move in the opposite direction of stock prices. The higher the VIX, the wider the expected distribution of stock prices, or the greater the spread between high and low prices, that is, the greater the volatility. A VIX below 12 indicates low volatility, that is, relatively stable market conditions. Anything above 20 reflects a high degree of uncertainty in the outlook for future stock prices—and a more volatile market.
Consider the VIX in action: On March 16,2020, the VIX closed at its highest level ever, 82.69, topping its previous highest close of 80.75 on November 21, 2008, the midst of the Great Recession. On March 23,2020, the S&P 500 landed at its lowest point of the COVID-19 crisis, down 34 percent from its February peak.
Some market participants suggest that when the VIX is greater than 42, it’s time to buy stock, and if it hits 55, commit all you’ve got. Of course, committing dollars to stocks under stress, even with a belief the market will eventually recover, is much easier said than done.
At HBKS, we don’t try to time the markets. Trying to do so has proven itself a fool’s game. But the VIX does give us a quantitative way to measure market risk and how investors feel about the future, which, in the end, is what drives the markets. As such, the VIX gets a great deal of attention from serious investors as a tool for looking forward at the market.
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