There’s no crystal ball for the stock market, but there are indexes that help investors gauge expected risk. The Cboe Volatility Index (VIX) is one such measure. It can offer a sense of future volatility, or how bumpy things could get, for the US stock market over the next 30 days. Learn how the VIX works, how it’s calculated, and what a high or low VIX could mean for your investments.
What is the Cboe Volatility Index (VIX)?
The Cboe Volatility Index, or the “VIX,” is a measure of the US stock market’s 30-day expected volatility—or how much and how quickly stock prices are anticipated to change. It’s often called “the fear gauge,” since higher volatility is linked with higher uncertainty among investors. VIX is this index’s ticker symbol. The index was created by the Chicago Board Options Exchange (aka Cboe, pronounced see-boh), which is a trading exchange like the New York Stock Exchange that’s focused on options contracts.
How does the VIX work?
The VIX measures the market’s expectations for volatility over the next 30 days based on what people are willing to buy and sell options for on the S&P 500 index.
What are options? They're contracts that allow investors to buy or sell a certain security at a certain price until a certain time. It’s like a bet on which way they think an investment’s price will move. Cboe uses the real-time data from options prices and quotes on its exchange to create a measure of how much the S&P 500’s index price is expected to move in the near future.
Generally, the higher the VIX, the less confidence investors have about future prices in the US stock market over the next 30 days. The lower the VIX (due to the lower relative options demand and prices), the more confidence investors may feel they have about US stock market prices over the next 30 days. The VIX tends to have an inverse relationship with the S&P 500’s price. In many cases, when the stock market goes down in price, the VIX increases. That said, the VIX is intended to measure short-term volatility rather than act as an index that’s always moving the opposite way as stock prices.
How is the VIX used?
Investors can use the VIX to help understand and anticipate potential price fluctuations in the stock market over the next 30 days. One way they might do this is by looking for trend reversals, such as the VIX coming down from recent highs, which could hint at a less-volatile S&P 500 in the near future. The VIX is based on expectations and not reality, and shouldn't be used as the basis for all investment decision making.
Other ways investors may use the VIX include:
- Gauging market sentiment: If the VIX is especially high or low, that could tip off an investor about what other investors might plan to do with their money. That could influence an investor’s own decision on whether to invest and in what.
- Managing risk: If the VIX rises sharply, signaling expected future market volatility, an investor could use that as a sign to shift their portfolio towards more conservative investments.
- Hedging: Some investors use securities tied to the VIX to hedge their portfolios in periods of volatility. That way, they’d potentially offset losses due to volatility in their other investments.
- Identifying buying opportunities: A rise in the VIX could indicate future price swings, potentially prompting a buying opportunity for forward-looking securities, like options, and helping investors choose a term length for those trades.
How is the VIX calculated?
The Cboe uses a complex calculation to arrive at the VIX—a number that changes in real-time throughout the day like stock and other index prices. The calculation takes into account the real-time average prices between the bid and ask for options with various future expiration dates. There’s more to it, but basically, the VIX is calculated as the square root of the expectation of price changes in the S&P 500 over the next 30 days.
What is a normal value of the VIX?
Based on data from the Federal Reserve of St. Louis, the historical average VIX value since its inception in 1993 is about 19.4.1 But there’s debate over the exact normal value of the VIX, and it depends on extended domestic and international economic pressures. The VIX can fluctuate at different levels depending on market conditions, so it may be impossible to peg a “normal” value.
What is a low value of the VIX?
Based on the Federal Reserve of St. Louis data, a value below the 19.4 average could be considered relatively low, meaning that investors don’t tend to expect large future price swings. However, whether the VIX is considered low is relative and depends also on what’s been happening recently. So if the VIX is lower compared to recent levels, it may be considered a low value for that time period.
What is a high value of the VIX?
By the same token, a value above the 19.4 average could be considered high, but it can potentially go much higher. During periods of great uncertainty, such as the 2008 financial crisis and the 2020 onset of the COVID-19 pandemic, the VIX hit end-of-month peaks in the 50s, according to the Federal Reserve of St. Louis. When the VIX rises to such high values, that means investors expect greater market volatility in the near future.
What to do when the VIX is high
When the VIX is high, keep your investing or financial plan top of mind. Volatility is a normal part of investing, and it’s smart to not react impulsively to price changes. Your investing or financial plan is there for a reason: to guide your investing decisions, no matter the market conditions. Learn 6 tips for navigating volatile markets.
How do you trade the VIX?
As with other indexes, you can’t invest in the VIX directly. However, you can trade the VIX through a variety of investment products, like exchange-traded funds (ETFs), exchange-traded notes (ETNs), and options that are tied to the VIX. Trading the VIX with these securities could be a hedging strategy, but like all investments, it carries risk, including the potential for volatility in the value of the VIX. Consider pursuing these advanced strategies only if you’re an experienced investor who understands the potential risks involved.