What is the VIX and how do you trade it?

Have you ever heard of traders and market participants talking about the VIX index? The VIX has been one of the most important benchmarks by which traders measure market uncertainty and general market volatility. This is why it is often termed the "Fear" index.

This index has evolved from just being a standard by which traders could gauge sentiment to a profitable way to trade the index for long-term gains.

What is the VIX?

The VIX is a measure of the implied volatility of options on the S&P 500 stock index. Implied volatility is the volatility that traders expect to occur over a period of time. This is the volatility that is priced into the options.

Volatility is measured in percentages but the VIX is an index level.

What does the VIX indicate

Given that the VIX is a measure of volatility that the market expects, it is an important measure of market sentiment. If traders are generally more worried about the outlook for stocks in the next few months, they would be willing to pay more for protection on stock market options.

This has the effect of increasing implied volatility and hence the VIX index. This increase in the value of the VIX index indicates that the market is more uncertain about the near term outlook and hence more fearful.

How do you trade the VIX?

Before the VIX index was created, traders could only take a view on market uncertainty and volatility by trading individual options on particular stocks or indexes. This was a less precise way to trade market uncertainty.

However, with the introduction of the VIX as a tradable product, traders were able to take position on the index itself. Initially it started out as a buying a future on the Index, but with the introduction of Binary Options, traders can now trade the index like they trade other instruments.

If an investor has a view that the VIX index will spike in the next 3 months, he / she can enter a Binary CALL option on the stock. Conversely, if the investor thinks that the index will sink he can enter a PUT option.

An example of a VIX trade

In the run-up to the UK's Brexit vote, the VIX index climbed to a yearly high. This was mainly because many institutional investors were uncertain as to the outcome of the vote. A smart Binary Option trader could have foreseen the potential uncertainty prior to the run-up in June (see chart below). The investor could have entered a Binary Option CALL option on the way up with an expiry just prior to the vote.

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On the other side, once the vote took place, uncertainty of the result was eventually cleared up. The institutional investors who had protected themselves by buying options prior to the vote were satisfied with their protection. The same trader could have seen the VIX slowly trending lower and entered a Binary Option PUT option. As illustrated above, the VIX index can also trend like other assets and hence can be analyzed from a technical perspective as well.

If Binary Option investors were looking for an upcoming event that could possibly help them take advantage of the VIX index, there is another important vote taking place in early November. There is still some potential uncertainty around the outcome of the U.S. election. More particularly, who will win the House and he Senate

Conclusion

The VIX index is more than a gauge on market "fear". It is a great way to profit from market uncertainty. This allows a Binary Options investor to make gains when the rest of the market (including institutional investors) are fearful and unwilling to take risks. 

6 Comments

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Visitor - jimmy: Style is always intermittent top replica watches in nature, with the fads repeating every so often.
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Visitor - David Benson: "I doubt the impact on the VIX would have been that much more different if it was a remain vote." Really? You're actually saying that you think VIX would have spiked up the morning after the vote if the vote had gone for "remain"? Really? Once again. Really?
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Visitor - Alex: I never knew you could trade the VIX with Binary options. Will definitely take a look at it more closely now!
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Visitor - Janet Preston: Thank you for your kind critique of my analysis. Perhaps the arrows could have been better placed :) May I point out that the VIX is an indication of the demand for insurance and it was spiking precisely because there were many institutional investors who were insuring their portfolios. Your comment about the % odds that were put on a "stay" vote is predicated on the assumption that the trade was a "bet" on an outcome. The trade could have been made irrespective of your view on the outcome on the vote. I doubt the impact on the VIX would have been that much more different if it was a remain vote. As you may well know, the VIX is an indication of implied volatility instead of realised volatility. It was a trade that could have been made irrespective of outcome. Trading the VIX is taking a view on upcoming market uncertainty and how to profit from it. This is not gambling but a careful analysis of volatility supply/demand, option skew and PUT/CALL ratios. I hope my explanation is able to assuage some of your points raised.
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Visitor - Janet Preston: Thank you for your kind critique of my analysis. Perhaps the arrows could have been better placed :) May I point out that the VIX is an indication of the demand for insurance and it was spiking precisely because there were many institutional investors who were insuring their portfolios. Your comment about the % odds that were put on a "stay" vote is predicated on the assumption that the trade was a "bet" on an outcome. The trade could have been made irrespective of your view on the outcome on the vote. I doubt the impact on the VIX would have been that much more different if it was a remain vote. As you may well know, the VIX is an indication of implied volatility instead of realised volatility. It was a trade that could have been made irrespective of outcome. Trading the VIX is taking a view on upcoming market uncertainty and how to profit from it. This is not gambling but a careful analysis of volatility supply/demand, option skew and PUT/CALL ratios. I hope my explanation is able to assuage some of your points raised.
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Visitor - David Benson: This is ridiculous analysis. And wrong. It implies with the stupid arrow that the "investor" (aka gambler) would have sold their call after the vote was in. Look at the arrow. If you had sold your option or VIX ETF, you would have taken a major loss, possibly as high as 100% if the vote went for remain, which had 92% odds. Let's review VIX closing prices "just prior to the vote" VIX closed on 6/16 at 19.37, 6/17 at 19.41, 6/20 at 18.37, 6/21 at 18.48, 6/22 at 21.17, 6/23 (the day of the vote) at 17.25. The outcome of the election was the surprise that spiked VIX. So your stupid arrow pointing up to the peak is just flat out false. I give your analysis an "F", for Foolish. On calls, you can lose 100%. If the vote had gone the other way, they would have lost close to 100%.
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