What is the VIX? How to Take Advantage of Stock Market Volatility with Wall Street’s ‘Fear Index’
- Weak US jobs data in July and higher interest rates in Japan sent the price of the VIX soaring
Market volatility has increased sharply as investors worry about the potential consequences of a further escalation of the conflict in the Middle East.
Oil prices rose after Iran’s missile attack on Israel overnight, amid fears that an escalation could weigh on supply in the region, as investors rushed to safe havens such as gold, which is within easy reach of its record high of $2,685 traded.
The defensive nature of the FTSE 100 has protected UK shares so far, but the Vix index – Wall Street’s so-called fear gauge – has risen almost 20 percent in the past 24 hours.
The VIX aims to track the expected volatility of the S&P 500 index, based on data from options contracts
You may have noticed unusually volatile swings in the value of your investment portfolio or pension over the past month.
Most experienced investors will tell you that the best policy during a sudden sell-off is to keep your nerve; often the quickest way to lose money is to sell.
But some investors are also looking to take advantage of panicky peers who are frantically buying and selling assets during periods of extreme volatility.
What is the VIX?
The CBOE Volatility Index, or VIX for short, acts almost as a barometer of investor confidence.
Launched in 1993, the closely watched index aims to track the expected volatility of the S&P 500 index, based on data from options contracts.
There are two types of options. A ‘call’ which gives the holder the right to buy a stock (or other asset) at a fixed price in the future, and a ‘put’ which gives the right to sell.
The index measures the market’s expectation of how much the price of major stocks will move over the next 30 days.
When the VIX is high, investors expect volatility and large price swings in the market, which is prominent during times of uncertainty.
When the VIX is low, investors expect minimal price movement and stability in the market.
How can UK investors invest in the VIX?
Investment opportunities in or around the VIX are very limited.
One option is through VIX Futures, which, according to Sam North, market analyst at eToro, may not be suitable for every investor “as it requires significant margin to trade.”
David Morrison, senior analyst at Trade Nation, says this is the best way for the British Investors can speculate on the VIX using VIX Exchange Traded Funds (ETFs).
North explains that ETFs allow investors to track the VIX, giving traders exposure and a tool “to hedge against future volatility in the markets.”
He continues: ‘Separately, some investors will use the VIX merely as a gauge for their other investments.
‘For example, a high VIX could be a good time to buy puts on the S&P 500 or other indices, or to reduce stock exposure, while a low VIX could indicate a more stable market where increasing stock positions could be beneficial are.’
eToro has ETFs that provide exposure to the VIX, such as UVXY and VXX. They also offer VIX Futures.
While at Trade Nation you can trade the VIX as a spread bet or CFD.
What risks should investors be aware of before investing in the VIX?
Clearly, investors should be wary of the volatility of the VIX when purchasing an ETF.
According to North, liquidity must also be taken into account by investors.
He said: ‘While some ETFs may have good liquidity, not all do, and as volatility increases so does the spread, meaning investors may not always be able to get in and out at the prices they want.
“When the S&P rises, VIX-related assets tend to fall and vice versa. These factors make VIX investing particularly challenging and require a nuanced understanding of the futures markets and volatility dynamics.”