A VIX of greater than 20% signifies increasing uncertainty and fear in the market and implies a higher-risk environment. During the 2008 Financial Crisis, the volatility index skyrocketed to extreme levels of above 50%. That meant that option traders expected stock prices to Broke Millennial fluctuate widely, between a 50% upswing or downswing within the next year, 68% of the time. When investors anticipate large upswings or downswings in stock prices, they often hedge their positions with options.

The more pronounced the options price swings on the S&P 500, the higher the risk of stock market volatility and the higher the VIX climbs — a signal that a crash may be imminent. Before we try to understand how the VIX is calculated, it’s important to grasp the basics of options contracts. You pay a premium for the right, but not the obligation, to buy or sell a stock at a specific price (called the strike price) by a specific date (the expiration date).

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A high VIX indicates high expected volatility and a low VIX number indicates low expected volatility. The more dramatic the price swings in that instrument, the higher the level of volatility. And the probability of S&P 500 trading within this specific range is 66.7% (or one standard deviation). Basically, if the S&P 500 is currently trading at 3,000, VIX is “implying” that over the next 12 months, its price will fluctuate between 2,100 and 3,900 (30% below and above 3,000). For example, a VIX of 30 translates to an implied volatility of 30% on the SPX. The VIX has an inverse relationship with the S&P 500, meaning that spikes in the VIX typically occur when stock prices drop.

Uses of the VIX Volatility Index

Downside risk can be adequately hedged by buying put options, the price of which depends on market volatility. Astute investors tend to buy options when the VIX is relatively low and put premiums are cheap. Volatility is one of the primary factors that affect stock and index options’ prices and premiums.

For example, on Nov. 9, 2017, the VIX climbed 22% during the trading session on fears of delays in the tax reform plan. As the derivatives markets matured, 10 years later, in 2003, the CBOE teamed up with Goldman long term trading forex Sachs and updated the methodology to calculate VIX differently.

Consulting with an independent, fiduciary financial planner before making moves in the market to ensure they are in line with your long-term goals is advised. While the VIX is a valuable tool, it’s important to understand its limitations. The result is the VIX value, representing the market’s expectation of 30-day volatility. Get stock recommendations, portfolio guidance, and more from The Motley Fool’s premium services.

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Learn how the VIX works, how it’s calculated, and what a high or low VIX could mean for your investments. The VIX, formally known as the Chicago Board Options Exchange (CBOE) Volatility Index, measures how much volatility professional investors think the S&P 500 index will experience over the next 30 days. The CBOE Volatility Index (VIX) is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX). Because it is derived from the prices of SPX index options with near-term expiration dates, it generates a 30-day forward projection of volatility.

Essentially, the VIX index is a forward-looking measure of how much the market expects the S&P 500 to fluctuate over the next 30 days, expressed as an annualized percentage. Profit and prosper with the best of Kiplinger’s advice on investing, taxes, retirement, personal finance and much more. Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more – straight to your e-mail. Julie Myhre-Nunes leads the Home Services team, covering home improvement, home warranties, home security, solar and moving. Before joining NerdWallet, she led editorial teams at Red Ventures and several startups. Her personal finance insights have been featured in Forbes, The Boston Globe and CNBC, while her writing has appeared in USA Today, Business Insider, Wired Insights and more.

• We do not include the universe of companies or financial offers that may be available to you.
• Market participants have used VIX futures and options to capitalize on this general difference between expected (implied) and realized (actual) volatility, and other types of volatility arbitrage strategies.
• You might consider shifting some of your portfolio to assets thought to be less risky, like bonds or money market funds.
• That’s why most everyday investors are best served by regularly investing in diversified, low-cost index funds and letting dollar-cost averaging smooth out any pricing swings over the long term.
• The VIX can help investors predict short-term performance, but the fluctuations shouldn’t concern long-term investors.

Q. Can the VIX predict market crashes?

Throughout its existence, the VIX has served as an invaluable witness to major market events. During the 1987 Black Monday crash, estimates suggest the index would have reached approximately 150 had it existed then. More recently, it hit dramatic peaks of 89.53 during the 2008 Financial Crisis and 82.69 amid the 2020 COVID-19 market crash.

Some of the more popular and active of these include the iPath Series B S&P 500 VIX Short Term Futures ETN (VXX), the ProShares Ultra VIX Short-Term Futures ETF (UVXY) and the Short VIX Short-Term Futures ETF (SVXY). But VIX-tracking funds are typically used by day traders and tend to be extraordinarily risky. The VIX can help investors predict short-term performance, but the fluctuations shouldn’t concern long-term investors. Based on the Federal Reserve of St. Louis data, a value of less than 20 could be considered relatively low, meaning that investors don’t tend to expect large future price swings.

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• Throughout its existence, the VIX has served as an invaluable witness to major market events.
• The investing information provided on this page is for educational purposes only.
• The price of these options is influenced by several factors, including the current stock price, the strike price, the time until expiration, and, crucially, the expected volatility of the underlying stock.
• Traders with a strong directional view of market volatility can use VIX futures, VIX options, or VIX ETFs to wager on their views.
• The VIX Index is calculated and disseminated overnight, providing market participants with real-time volatility information whenever news breaks.

The CBOE S&P 500 Volatility Index (VIX) is known ig forex broker review as the “Fear Index” because it is such a helpful gauge to measure how worried traders are that the S&P 500 might suddenly drop within the next 30 days. Melissa Pistilli has been reporting on the markets and educating investors since 2006. She has covered a wide variety of industries in the investment space including mining, cannabis, tech and pharmaceuticals.

Understanding how the VIX works and what it’s saying can help short-term traders tweak their portfolios and get a feel for where the market is headed. CFE lists nine standard (monthly) VIX futures contracts, and six weekly expirations in VIX futures. As such, there is a wide variety of potential calendar spreading opportunities depending on expectations for implied volatility. In more practical terms, the VIX uses option prices to estimate how volatile the market will be in the coming month, and then extrapolates that to the next 12 months.

The VIX is typically used to measure short-term investor sentiment, but many also use the index as a foundation for active investing strategies. Before investing in any VIX exchange-traded products, you should understand some of the issues that can come with them. Certain VIX-based ETNs and ETFs have less liquidity than you’d expect from more familiar exchange traded securities. ETNs in particular can be less liquid and more difficult to trade as well as may carry higher fees.

Imagine the stock market has been steadily climbing for months, and the VIX index is hovering around 12. However, news breaks that a major global event (e.g., a geopolitical crisis, a major economic announcement) is imminent. Investors become concerned about the potential impact on the market and start buying put options to protect their portfolios. This signals increased uncertainty and the potential for a market correction. However, in recent decades, new financial products have transformed volatility into an asset that can be traded. This shift began in earnest with the introduction of VIX futures in 2004 and VIX options in 2006 by the Chicago Board Options Exchange.