CBOE Volatility Index (VIX): what it is and how to trade

Real-time market indices such as the VIX (INDEXCBOE:VIX) measure the stock market’s expectation of forward-looking market volatility (in this case, 30 days).

In simplistic terms, the VIX is a measure of how much traders are willing to buy or sell the S&P 500 index, which is a measure of the top 500 companies listed on US exchanges by market cap. The more traders are prepared to risk, the more volatile the market is likely to be. However, it is worth noting that the VIX is about implied volatility — what is likely to happen, not what definitely will happen.

The index was created in 1993 by the Chicago Board Options Exchange (CBOE) and since 2002, it has derived its value from the price inputs of the S&P 500 options, therefore representing the expectation of market risk and volatility. Also known as the CBOE index, it’s unusual in deriving its value not from stocks, but from options prices.

The VIX volatility index is known by other terms such as the ‘fear gauge’ or ‘fear index’. For traders, it provides an efficient method to judge market risk, fear and uncertainty when making trading decisions.

As it essentially measures uncertainty, the VIX volatility index is an appropriate name. But this is a good thing — not only can it indicate whether the market is generally bullish or bearish​ and therefore influence trading decisions, but it can also provide opportunities for trading itself.

CBOE’s volatility index was designed to measure the sentiment in the market. The calculations are complicated, but essentially the VIX measures implied volatility by averaging the weighted prices of a wide range of put and call options (respectively, the right to sell or buy a stock) from the S&P 500.

When traders buy and sell options, the positions they take (either puts or calls), the prices they are willing to pay, and the strike prices they choose all reflect how much and how quickly they think the underlying index level will move. By judging how far the put and call prices are distributed from the current price of the S&P 500, the volatility index draws an average, which is represented by VIX’s current price. These calculations produce a quantifiable measure of market outlook and volatility for the following 30 days.

The VIX volatility index does not record volatility – it forecasts it, based on data around options. The data it gathers implies how much volatility there is likely to be within the next 30 days and is an extremely useful pointer. But traders should take into account that while it is an effective tool based on solid data, it is a forecast, not a fact.

The greater the risk, the more people are willing to pay for ‘insurance’ in the form of options. This means the higher the perceived level of risk — for example, in times of high uncertainty, such as during the Covid-19 pandemic or the Russian invasion of Ukraine — the higher the VIX price climbs.

When equity markets seem stable and stocks are high, premiums on options decline, alongside volatility instruments like the VIX.

World events in recent years clearly demonstrate how the index works in mirroring the market sentiment​ — that is, doing the exact opposite of — the S&P 500 and other stock indices. For example, when the Covid-19 crisis hit, the VIX soared to $82, surpassing even the previous high of $80.86 recorded during the financial crisis of 2008.

This is an exchange-traded fund providing exposure to the S&P 500 VIX Short-Term Futures Index, which measures the returns of a portfolio of monthly VIX futures contracts​ with a weighted average of one month to expiration. This VIX ETF is designed for advanced traders and, as the name suggests, is intended for short-term leveraged trading as an effective hedging instrument to the S&P.

As the VIX spikes when market anxiety is high, it tends to rise in value as stocks fall. It’s also linked to an index comprising short-term futures, so it may be most appropriate for those looking to place a short-term bet against the market rather than a long-term hold.

An example of a VIX ETN is the iPath Series B S&P 500 Short-Term Futures ETN. The fund is managed by Barclays Capital Incorporated, which tracks the futures on VIX through the S&P 500 VIX Short-Term Futures Total Return Index.

Exchange-traded notes are traded like ETFs but have some differences: they’re unsecured debt securities, with a specific maturity date, issued usually by a bank, that track a particular index. Traders can hold shares until the ETN’s debt security matures but can buy or sell before then.

At CMC Markets, we have the educational tools and market insights to support your trades, as well as educational training guides, webinars and platform tutorials​. Whether you’re using our website or app, we can guide you through the features and tools available, give you access to market news and charts, help you place different order types, and we also offer a live help chat service. Whether you want to trade on a VIX-related index or elsewhere, our CMC dealers work with you to put into action your decisions and complete the trades you want to make.

Read more about our derivative trading products below.

VIX spread betting is a form of leveraged trading, which means that you do not physically own the financial instrument but are instead speculating on its price movements. This involves putting down a deposit that could ultimately be outweighed by either a profit or loss. Spread bets carry no capital gains tax in the UK*, which makes it a popular option for traders.

The natural divergence of the stock market and the VIX index makes volatility trading an attractive way to manage risk and hedge your bets through options or futures contracts. CFD trading is another method of derivative trading where, as a trader, you agree to exchange the difference in price (positive or negative) between when you open and close your position, and the more the index moves, the more you gain or lose, depending on which way you bet. In contrast to spread bets, profits on CFD trades are liable for capital gains tax.

A stable economic environment would ordinarily suggest short-selling volatility. In this case, you would expect little volatility, and the more the markets rise, the more the VIX would fall, putting you in profit. The downside is that unexpected high volatility in such a position could leave you extremely exposed to unlimited losses.

Whereas, if you believe the stock market will fall — and overall investor fear is high — or foresee a social or political event likely to bring uncertainty, then you may choose to take a long position on the VIX if you are expecting a spike. However, if your doomsday predictions don’t pan out and the market stays calm, your VIX volatility index long position may lose you money.

When market fear is high, so is the price of the VIX index, whereas a lower VIX price can be a sign of either greed or investor complacency. Using the index alongside other measures of volatility and market outlook can help to provide crucial clues into current investor sentiment and an index’s prospects. Finally, the VIX volatility index is just a single model of volatility. Combining multiple models and inputs in your trading can provide you with less risk exposure when compared with betting on a single variable.