Option Investor
Market Updates

Tracking The VIX

Printer friendly version

The CBOE Market Volatility Index (VIX.X) is a measure of implied volatility. It is constructed with a weighted average of the implied volatilities of eight OEX calls and puts. The contracts used to calculate the index have an average expiration of 30 days.

Implied volatility is a big component of option prices; it is the market's expectations for annual fluctuations in price. In the case of the VIX.X, the reading is the consensus of the market's expectations for future swings in the S&P 100 ($OEX).

Generally, a high reading in the VIX.X reveals fear among market participants. Increased fear brings with it increased expectations for volatility. Consequently, the VIX.X tends to ascend much more quickly than it descends. Stocks fall three times as fast as they rise due to the overpowering nature of fear.

Conversely, a low reading in the VIX.X reveals complacency among options market participants, a sense of security. A low VIX.X reveals the market's expectations for mild movement in the $OEX.

The VIX.X is traditionally used as a contrarian indicator for sentiment purposes. The foundation for the theory is that the crowd can't be right, so it pays to fade the prevailing sentiment. Here's a common mantra among contrarians when viewing the VIX.X:

When the VIX.X is low, it's time to go (Read: Sell)
When the VIX.X is high, it's time to buy

The VIX.X is trading at relatively low levels, but does that mean it's time to go? Like any other market indicator, the VIX.X viewed in a vacuum is dangerous. It needs to be related to other indicators, either strengthening or weakening a current market thesis.

With that written, the following chart reveals a distinct pattern of low levels in the VIX.X corresponding with subsequent weakness in the $OEX:

VIX/OEX Comparison

The VIX.X is currently trading near the lower-end of its historical range, which reveals complacency on the part of option market participants. Are they right? Is there nothing to fear in the current political and economic environment? I'm not smart enough to answer those questions. But I do know that it's worth while to work the VIX.X into your current market thesis, especially how you view risk to the upside and downside. A market that is complacent and comfortable is one in which risks are greater to the downside.

Eric Utley
Option Investor

Intraday Update Archives