Investors are always looking for an edge when it comes to the stock market. They scan financial news, listen to "experts" on podcasts and pay attention to earnings calls to discover new information that could lead to a successful trade.
Many tools, measurements, and indices are available to help traders on their path to successful investing. One of those is what's known as the CBOE Volatility Index, or VIX for short. But, what is the VIX, and how can traders use this valuable financial tool?
Experienced investor Dan Calugar breaks it all down.
What the Index Is
The Chicago Board Options Exchange, or CBOE, created the VIX. It aims to provide a measure of investor sentiment and market risk that is quantifiable.
The VIX is real-time, representing the expectations in the market for the strength of the S&P 500 index in the near term. The index is derived from options of the S&P 500 and provides a projection of market volatility for the next 30 days.
Many investors use volatility to determine whether it is a good time to jump into the market or jump out of it.
The VIX is represented as a percentage. When the value of the VIX goes up, it's likely the S&P 500 index is declining. When the value of the VIX goes down, then a likely period of stability is happening in the S&P 500.
Some investors may be wary of the fact that the VIX only tracks the S&P 500. However, the index is used very commonly as an overall benchmark for the entire stock market in the United States.
How Investors Can Use the VIX
There are two main ways investors can use the VIX -- either as a research tool or by trading the VIX itself.
Dan Calugar believes that focusing on options pricing can serve as a solid volatility measure for the stock market. If investors are concerned about something in the market, they often turn to options buying. When options are traded, they will be reflected in the VIX, which can then be used as a tool to make investment decisions.
Like anything in the stock market, though, the VIX is only a predictor of volatility. Nothing in the stock market is certain. As such, it's best to use data from the VIX in combination with other research and analysis before making final investing decisions.
Traders can also invest directly in the VIX itself. For example, you can sell and buy futures and options that are based in the VIX.
The easiest way to do so is through exchange-traded notes (ETNs) or exchange-traded funds (ETFs) based on the VIX futures. Investors can easily sell and buy securities such as these just as they would individual stocks, which makes harnessing the power of the VIX much more straightforward.
The VIX is an extremely powerful investment tool for traders looking to predict the near-term volatility of the market. Understanding the index and the information it can provide can go a long way in ensuring solid market returns.