VIX Volatility Index Futures: Trading Stock Market Sentiment
VIX Volatility Index - specialist design Chicago Board Options Exchange CBOE. The indicators began to be calculated in 1993, although the idea of creating such an instrument emerged much earlier - in 1986. The invention belongs to the American professor Menachem Brenner and his Israeli colleague Den Galai.
VIX - "Fear Index" of traders
This tool allows you to Determine market sentimentIt is a critical component of the analysis of the current trading situation along with the EUR/USD exchange rate or the S&P 500 and Dow Jones indices. The main advantage of the VIX is that traders do not get a fuzzy definition, but an assessment of fear or, conversely, optimism, clearly expressed in numerical terms.
Investor sentiment is reflected in the volatility index as follows: The higher the indicator values, the brighter the anxiety of financial market participants. If the indicator begins to decline, it means that an optimistic mood prevails. It is for this reason that the VIX is often referred to asfear index".
When working with an index and its associated derivatives It should be taken into account that it is a reflection not of real, but of expected price fluctuations. And the time for which the volatility is predicted corresponds to a period of 30 days. The notion of forecasted changes is also characterized by the term implement volatility (implied volatility).
Today there are about 25 different group volatility indices VIX. These include indicators showing investor sentiment on oil, gold, interest rates, soybeans, corn and wheat. It is impossible not to mention the existence of a very unusual volatility index - on the volatility index itself. It is not in high demand from investors and is rather an exotic instrument.
The most popular is undoubtedly the original version of the index, whose results are calculated using the Black-Scholes formula. The S&P 500 options trading figures are used as the base value.
The most significant peak on the volatility index chart is still the one seen in October 2008. The peak was reached due to the incredible level of panic that gripped the world market during the 2008-2009 economic crisis. In the next two years, the aftershocks of one of the biggest shocks of the 21st century were still felt, so quotes were not stable.
Using the VIX index in market analysis
The historical data of the VIX index indicators allow us to identify the average value, which can be conventionally considered comfortable leveli.e., a situation in which calm prevails on the stock market. If we take a broad enough range, the emotional equilibrium zone can be tied to the corridor of the index value between 10,000 and 19,000. Throughout 2013, for example, the VIX quotation was located exactly in this area as stocks of major corporations were moving up smoothly without raising concerns about a reversal.
A comparative analysis of the S&P 500 and VIX index charts clearly reveals reverse correlation of these indicators. The reason for the appearance of multidirectional dynamics is quite simple. At moments of a significant decline in the value of stocks and, consequently, the "barometer" of the stock market falls, traders go in search of other assets to hedge their investments. And in conditions of mass panic they are willing to pay much more for insurance than in calm times. Expecting a serious reversal from the S&P 500, investors "push" the VIX quote higher and higher, and it, in turn, demonstrates market stress increasing to the limit.
The divergence becomes especially noticeable when the S&P 500 Index moves to its historical highs or lows. The points of contact of the indicators, as a rule, give the start for the next "run" of quotations in opposite directions. This pattern can serve as signal when deciding to enter or leave a position.
RTSVX - analog of the VIX index
If we consider the nearest analogues of the U.S. volatility index VIX, we should pay attention to the financial product with stock ticker RTSVX (Russian traders will find it especially attractive). This indicator tracks market sentiment based on the performance of futures options on RTS Index. By the way, this instrument was not chosen as an underlying asset by chance: it is the most liquid one on the Russian futures market, and therefore characterizes it somewhat better than other indicators. In spite of the fact that the methods of calculation of American and Russian indices are somewhat different due to the discount to the distinctive features of the national financial platforms, the basic principle is still the same.
The RTSVX volatility index itself appeared in early 2006, but futures on it became available only 5 years later - in 2011. At the moment, the liquidity of this contract is low, but analysts predict a wave of interest from traders who realized the possibilities of the derivative on RTSVX in the near future.
VIX futures as a tool for volatility trading
On March 26, 2006, the first VIX volatility index futures. With the introduction of this contract, traders and investors have fundamentally new opportunities to build trading strategies. It is especially relevant for owners of options or futures portfolios and stock market participants, as it allows them to assess the risk level of their investments and, if necessary, hedge them reliably. In addition, a separate group of volatility traders appeared, playing on attempts to determine the depth of price fluctuations or, in other words, to "catch the wave" of sentiment and trade against the "stock crowd".
Splashes or sharp drops are quite standard for the VIX index futures chart. If we consider shorter timeframes, we can note the high volatility quotes: for example, from the value of 16.40 the curve went down to 13.35 in just one week (December 17, 2013 - December 24, 2013). This means that the weekly fluctuation range was about 20 %.
Despite criticism by some analysts of the VIX Volatility Index and futures contracts on it (they complain about insufficient adequacy of forecasts), these innovative developments of the Chicago Exchange CBOE, which opened a lot of opportunities for traders, today have quite justifiably high trading volumes.
The article was prepared by Sergey Krasikov, Senior Financial Consultant at Saxo Bank