Jon Lewis

Understanding the VIX and Using it to Your Advantage

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Actually, there are two other "VIXs," the CBOE Nasdaq Volatility Index (VXN), which tracks the Nasdaq 100 Index, and the Dow Jones Industrial Average Volatility Index (VXD). The calculations and methodology are essentially the same; they just use different index options. However, you won't hear about VXN or VXD too often. The VIX is the main show.

The VIX and Market Analysis

Let's get back to what the VIX measures -- fear and pessimism.

The VIX typically hits historic highs during periods of extreme market turmoil. Note in the monthly chart below how the VIX peaked during market crises -- the Long-Term Capital Management and Russian debt crises in 1998; Sept. 11, 2001; and the major market bottom in 2002. More recently, the VIX spiked (that's an understatement) at the October 2008 bottom and, to a lesser degree, at the March 2009 bottom.

The other notable feature of the VIX is that it tends to move opposite the SPX. So when the SPX is declining, the VIX is on the rise. That makes intuitive sense, since volatility usually increases during a decline. On the other hand, the VIX tends to decline during bull periods. Sentiment becomes complacent and volatility contracts, so the VIX tends to drop.