{"id":329,"date":"2023-08-25T05:02:22","date_gmt":"2023-08-25T09:02:22","guid":{"rendered":"https:\/\/www.tiingo.com\/blog\/?p=329"},"modified":"2023-08-25T07:20:17","modified_gmt":"2023-08-25T11:20:17","slug":"how-to-trade-the-vix","status":"publish","type":"post","link":"https:\/\/www.tiingo.com\/blog\/how-to-trade-the-vix\/","title":{"rendered":"Investing in Volatility: How to Trade the VIX"},"content":{"rendered":"
\n
\"How<\/figure>\n<\/div>\n\n\n

The Volatility Index (VIX) is managed by the Chicago Board Options Exchange (CBOE). It measures, monitors, and reflects how the market feels about the near-term volatility (30-day projections) of the S&P 500 Index (SPX) options price expiration dates.<\/p>\n\n\n\n

Hence, the CBOE VIX can be used to trade on and profit from market volatility and fear- or hope-based sentiment. Investors and traders can long or short the VIX, use AI and algorithmic trading to execute fast-paced VIX trades, and include it in a widespread investment portfolio.<\/p>\n\n\n\n

In this article, we explain how to trade the VIX and give you a more in-depth look at how to leverage fear, hope, and market volatility when making investments.<\/p>\n\n\n\n

And just to make it clear, it\u2019s technically not possible to trade the VIX since it\u2019s an index, in other words, a math calculation. But what we can trade are derivatives around the VIX, that give us VIX exposure. This article will discuss these VIX derivatives and instruments.<\/p>\n\n\n\n

What Is the <\/strong>CBOE Volatility Index<\/strong>? <\/strong><\/h2>\n\n\n\n

Let\u2019s start by clarifying the role of the CBOE with the VIX. Put simply, the CBOE created the VIX as a financial trading product that\u2019s now bought and sold worldwide.<\/p>\n\n\n\n

The Chicago Board Options Exchange (CBOE)<\/a> is a stock, index, and futures exchange managed by CBOE Global Markets. The CBOE is a comparable and competing operation to the NYSE, NASDAQ, London Stock Exchange, and numerous others, except it\u2019s smaller, relatively speaking.<\/p>\n\n\n\n

It has been going for 50 years, and every day, it sees $63 billion traded in U.S. equities, 10 million U.S. options contracts, $43 billion in forex trading<\/a>, and over 212,000 U.S. futures contracts.<\/p>\n\n\n\n

The VIX, although derived from S&P 500 Index options price volatility, is a CBOE financial product, making CBOE \u201cthe home of the VIX.\u201d<\/p>\n\n\n\n

The VIX Index calculations are based on real-time, mid-quote S&P 500 Index call and put options. It\u2019s a constant way of measuring and trading in 30-day SPX volatility.<\/p>\n\n\n\n

The VIX serves two purposes. Like any financial product, it can be traded, and investors and day traders can do this in several ways \u23e4 which will discuss later. <\/p>\n\n\n\n

At the same time, as the CBOE says<\/a>, the VIX is \u201cone of the most recognized measures of volatility\u201d and is closely followed and reported in the financial media as an indicator of the amount of fear, risk appetites, and hope impacting the movements of the stock market and market sentiment.<\/p>\n\n\n\n

What Is <\/strong>Implied Volatility<\/strong>?<\/strong><\/h2>\n\n\n\n

Stock markets are volatile. Share prices can go up, down, and sideways. Unless you\u2019ve got a healthy appetite for risk, the ability to accurately predict the future (and the stock price data to back it up), and finely tuned AI-powered algorithmic trading tools<\/a> to execute lightning-fast trades, you could quickly lose gains from sudden volatile price movement.<\/p>\n\n\n\n

Unexpected price collapses can wipe out months or years of gains in hours or minutes. It\u2019s essential that investors, brokers, and analysts understand volatility and how to calculate it, and then leverage this knowledge for investment strategies.<\/p>\n\n\n\n

Uncertainty is another way to say volatility. If you\u2019re unsure how much a particular security, index, commodity, futures contract, or forex price will fluctuate, it means you\u2019re assessing its volatility. If you\u2019re more sure about a security’s forward price movements, then the potential volatility is lower.<\/p>\n\n\n\n

However, in more exact terms, volatility is a calculable metric<\/a> used to statistically measure a security’s (or other financial asset’s) potential returns. Volatility can be calculated over any time period, from daily to annual timescales or longer. <\/p>\n\n\n\n

For short-term traders, it\u2019s more useful to calculate volatility over a more compressed timescale, such as the last 30 days. That\u2019s the time period the VIX operates on.<\/p>\n\n\n\n

Implied volatility<\/a> is a forward-looking way of forecasting, as accurately as possible, expected or potential volatility in the future (as opposed to calculations that are historical<\/a> in nature). One way to calculate it is with the Black-Scholes-Merton options and future-pricing model, using the fair or mid-quote price of a call or put option of a security.<\/p>\n\n\n\n

A theoretical, data-backed, and backtested<\/a> understanding of calculating volatility, with active knowledge of technical indicators<\/a>, is useful for investors who want to know how to trade the VIX. <\/p>\n\n\n\n

Why Should Investors Trade the VIX?<\/strong><\/h2>\n\n\n
\n
\"Close<\/figure>\n<\/div>\n\n\n

The VIX can be traded in numerous ways, including VIX futures contracts, index options, derivatives, exchange-traded funds, and exchange-traded notes \u23e4 and through the CBOE\u2019s VIX Suite.<\/p>\n\n\n\n

The main reason market participants trade a volatility-based product is that it\u2019s a way of hedging against the volatility of the S&P 500 Index. In most cases, VIX trading is simply part of a broader, risk-adjusted investment portfolio and strategy, whereby traders can offset wins and losses whether the market is \u200cbullish or bearish.<\/p>\n\n\n\n

There\u2019s a strong correlation between volatility on the S&P 500 and the VIX. If the SPX is falling, then the VIX goes up and vice versa, making it a useful weather-monitoring station for market sentiment.<\/p>\n\n\n\n

Generally speaking, if the VIX is trading below $20, then the S&P 500 is probably stable, with low volatility. When the VIX price is above $30, then it\u2019s a sign of volatility.<\/p>\n\n\n\n

3 Considerations When Trading the VIX <\/strong><\/h2>\n\n\n\n

Here are three considerations investors should take into account when trading the VIX. <\/p>\n\n\n\n

1. Understand the Fundamentals of VIX Volatility Trading <\/strong><\/h3>\n\n\n\n

At the end of the day, any VIX trading strategy is about being comfortable with calculating and predicting future volatility. In practice, this means understanding that VIX values are based on CBOE-traded SPX options. <\/p>\n\n\n\n

These index options have a futures price that expires on the third Friday of each month, and the weekly SPX futures options expire every other Friday (at the close of trade). The only options used for VIX values are those that have expiration dates between 23 and 37 days. It\u2019s a complex mathematical formula<\/a>. <\/p>\n\n\n\n

2. Respect the VIX <\/strong>S&P 500 Index<\/strong> Correlations <\/strong><\/h3>\n\n\n\n

The correlation between the S&P 500 Index and the VIX is inverse. As mentioned earlier, if the SPX is going up, then the VIX falls and vice versa. It\u2019s a way of measuring market fear (hence the VIX is known as the \u201cfear index\u201d), sentiment, and volatility, making those inverse correlations crucial for successful VIX trading. <\/p>\n\n\n\n

3. Be Mindful That the VIX Is an Index <\/strong><\/h3>\n\n\n\n

As is the case with any index, you aren\u2019t trading an actual asset. As an index, the VIX can only be traded through derivatives that track the movements of the index. <\/p>\n\n\n\n

For this reason, there\u2019s usually a tiny lag between the prices you\u2019re seeing through any product you\u2019re using to trade the VIX and the actual real-time percentage price the VIX is trading at.<\/p>\n\n\n\n

How to Trade the VIX: 5 Trading Options <\/strong><\/h2>\n\n\n
\n
\"How<\/figure>\n<\/div>\n\n\n

Source: Google Finance<\/a><\/em><\/p>\n\n\n\n

Now let\u2019s take a closer look at how <\/em>to trade the VIX, including a number of exchange-traded fund (ETF) and exchange-traded note (ETN) options. <\/p>\n\n\n\n

1. CBOE\u2019s VIX Trading Suite <\/strong><\/h3>\n\n\n\n

One of the easiest ways to trade the VIX is to go straight to the source: CBOE\u2019s VIX Volatility products trading suite<\/a>. From here, you can trade in the VIX 24\/7 through a range of products: <\/p>\n\n\n\n