Traders can profit from volatility in financial markets using several strategies such as using options (long straddle, long strangle,…), using short term strategies or simply buying VIX options and futures. The VIX, or Chicago Board Options Exchange (CBOE) Volatility Index, is a real-time market index that measures the expected volatility of the S&P 500 Index over the next 30 days.
The VIX (CBOE Volatility Index) is crucial for traders for several reasons:
Trading opportunities: Traders can speculate on volatility levels using VIX futures, options, and exchange-traded products. This allows for strategies such as long/short volatility trades and risk premium yield strategies.
Options pricing: The VIX influences options prices. When the VIX rises, demand for options increases, making them more expensive. This information helps traders make informed decisions about options trading.
Market sentiment indicator: The VIX serves as a "fear index," reflecting the level of risk, fear, or stress in the market. It helps traders gauge investor sentiment and market expectations for volatility over the coming 30 days.
Portfolio hedging: Due to its strong negative correlation with the S&P 500, traders use VIX-linked instruments to diversify portfolios and hedge market exposure. A long exposure to volatility may offset the adverse impact of falling stock prices.
Market timing: Some traders use VIX levels to identify potential market tops and bottoms. There's a saying: "When the VIX is high, it's time to buy. When the VIX is low, look out below".
By understanding and utilizing the VIX, traders can make more informed decisions about risk management, portfolio diversification, and potential trading opportunities in volatile market conditions.
How to interpret VIX?
Volatility Expectations: The VIX value represents the market's expectation of percentage movement in the S&P 500 over the next 30 days.
Expected Daily Move: Using the "Rule of 16," a VIX of 16 implies an expected daily move of about 1% in the S&P 500.
The VIX index is read as a percentage and fluctuates between 0 and 100. Here's how to interpret VIX values:
Below 12: Low volatility
Between 12 and 20: Normal volatility
Above 20: High volatility
30 and over: Extreme volatility, indicating heightened investor fear and market uncertainty
Some traders view extremely high VIX readings as potential buy signals for stocks, as it may indicate a market bottom.
Traders use VIX to gauge market risk and adjust their strategies accordingly. Higher VIX levels may prompt more defensive positions.
Risk loving traders can also focus on leveraged VIX ETFs in order to maximize their profits. Leveraged VIX ETFs are complex financial instruments that aim to provide amplified exposure to the CBOE Volatility Index (VIX) or VIX futures. These products are designed for sophisticated investors seeking to capitalize on or hedge against market volatility. Leverage in investing refers to the use of borrowed funds to increase the potential return on an investment. By using leverage, investors or companies can amplify their buying power, enabling them to control a larger investment than would be possible with their own capital alone. However, leverage also increases the potential for losses, making it a high-risk, high-reward strategy.
Here is a short list of some leveraged ETFs