Stock market volatility is a well-known concept among investors, but what exactly is volatility and how is it measured? The VIX, an index that tracks volatility, has been in the spotlight during times of financial turmoil. In August 2024, the VIX surged above 60, a level not seen since the market crash in the early stages of the COVID-19 pandemic in March 2020, sparking concerns about a potential recession.
Understanding the VIX can be complex, so let’s delve deeper into its significance.
Exploring the Cboe Volatility Index (VIX)
The VIX is an index operated by the Chicago Board Options Exchange, now known as Cboe, that gauges the market’s anticipation of volatility over the next 30 days based on option prices for the S&P 500 stock index. Volatility is a statistical measure reflecting the extent to which an asset’s price fluctuates in either direction, commonly used to assess the risk level of an asset or security.
Introduced in 1993, the VIX is often referred to as the “fear index” as it provides traders and investors with insights into market sentiment and the level of fear or uncertainty prevailing in the market. Typically, the VIX spikes during or in anticipation of a stock market correction, with higher levels indicating expectations of increased volatility.
In March 2020, amidst the rising concerns surrounding the COVID-19 pandemic and its economic impact, the VIX hit a record high of 82.69, surpassing its previous peak of 80.86 recorded during the 2008 global financial crisis. Throughout its history, the VIX has generally ranged between 10 and 30.
Measuring Volatility
The VIX aims to predict volatility over the next 30 days, although not with absolute precision. A VIX reading of 25 does not imply that volatility will average 25% over the following month. Studies have shown that the VIX tends to overestimate volatility by around 4 to 5 percent, but it still holds predictive value. Here are some general guidelines on what different VIX levels indicate about future volatility:
- VIX of 0-12: Low volatility is expected at this level. The lowest daily closing value for the VIX was 9.14 in November 2017.
- VIX of 13-19: This range denotes normal volatility expectations for the next 30 days.
- VIX of 20 or higher: Volatility is anticipated to be higher than normal when the VIX surpasses 20. This level is typically reached during periods of market stress, such as economic slowdowns or recessions. During extreme events like financial crises or pandemics, the VIX may exceed 50.
It’s important to note that these are general guidelines, and unforeseen events can disrupt markets, potentially leading to periods of extreme volatility despite low VIX levels.
Investing in the VIX
Directly investing in the VIX is not feasible, but you can opt for ETFs that track the index to speculate on future VIX changes or as a hedging tool. While this may not align with the long-term goals of most investors, it can be beneficial for those inclined towards trading and speculation. When market uncertainty arises, stocks typically decline, potentially impacting your portfolio. However, even the best volatility ETFs tend to decrease in value over time, despite occasional spikes during periods of heightened volatility.
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Key Takeaways
The VIX serves as an indicator of future volatility expectations, often rising during market stress periods, making it a valuable hedging tool for active traders. While direct investment in the VIX is not possible, ETFs tracking the VIX offer opportunities for speculation. A VIX level exceeding 20 suggests elevated volatility in the upcoming weeks.
Editorial Disclaimer: It is recommended that all investors conduct thorough independent research on investment strategies before making decisions. Additionally, past performance of investment products does not guarantee future price appreciation.