John Jagerson

Predicting Volatility With the VIX

    Tweet This

Free Trading Guides

This article is brought to you by LearningMarkets.com.

The CBOE Volatility Index (VIX) is a technical indicator and a security you can trade all in one. It is arguably the best gauge of risk and sentiment available to the investing public, and can be used effectively by any trader within any market.

This series of articles will define what the VIX is and how it works. You will learn how to use it within your daily analysis, and how to invest or trade the VIX as a potential source of profits.

The VIX is often nicknamed the "fear index," which is actually somewhat misleading since it doesn't directly measure fear of any kind. The VIX is actually a measure of trader's expectations about volatility in the S&P 500 (SPX).

The VIX is charted like an index, and the higher it goes, the higher trader's expectations are for short-term market volatility. (Discover 5 Ways to Profit From Volatility.)

The VIX rises with higher market volatility because it measures the prices of the out-of-the-money S&P 500 index options. (Learn about what happens when the VIX disagrees with market direction.)

If option sellers think volatility is going to increase in the near term, they will require larger premiums from option buyers. This increase in option prices is used in the calculation for the VIX index. Conversely, if traders think volatility is going to drop, option sellers will have to reduce premiums to attract buyers. Falling option prices will be reflected in a falling VIX index.

The VIX will track these changes in investor sentiment and option premiums in real time each trading day. The VIX is reading 30 or 30% as this article is being written, which is an annualized number of how much traders think the S&P 500 will move over the next 30 days. That means that traders think the S&P 500 is likely to move about 2.5% (30% divided by 12 months = 2.5%) over the next month.