The CBOE VIX (Volatility Index) is a measure of the expected volatility of the S&P 500 index over the next 30 days.
It is calculated using the prices of options contracts on the S&P 500, with a focus on the ones expiring in 30 days. The higher the VIX, the higher the expected volatility, and vice versa. The VIX is often referred to as the "fear index" because it tends to rise during times of market stress and uncertainty.
The VIX has several "little brothers" that measure the expected volatility over different time horizons. The VIX9D measures the expected volatility over the next 9 days, the VIX3M measures the expected volatility over the next 3 months, the VIX6M measures the expected volatility over the next 6 months, and the VIX1Y measures the expected volatility over the next year. These indexes are calculated in the same way as the VIX, but with options contracts expiring over the respective time horizons. These indexes can give traders and investors an idea of how volatile the market is expected to be over different time frames. Please note that these are not filtered versions using SMA or EMA on the given time horizon, but the real calculation using the option taken on this timeline. This nuance is important as filtering a value creates a lagging effect where VIX9D, VIX, VIX3M, VIX6M and VIX1Y are instantaneous measurements.
In a normal market, these curves are supposed to be in contango since we can expect that the bets that are further in time have more uncertainty and thus a higher standard deviation. However, when we are starting a correction, the order of these curves tends to invert. Some institutional traders only go long on the market when this ribbon is in the right order and with a certain width.
Hidden in the parameters of this indicator, you will also find two other signals. One is the normalized width of the ribbon. We can usually observe that an extreme width value is often associated with an overstretched market that will soon see a reversal. This can be a good signal to deleverage. The other signal provided is how many standard deviations the width is currently from its 5-month average. Only the values over 1.6 standard deviations are kept. They are other great signals of the market currently being overstretched by the standards of the very actual market.
Not only is the VIX structure an important component of our hedge signal during bear markets and other phases, but the VIX can also be a very interesting tool that can help us trade volatility successfully or provide an intrinsic way of protecting a portfolio. One of the reasons WealthUmbrella likes this play is that volatility can lead to trades that have a very asymmetric risk-reward profile. Indeed, it rarely goes under 14 but can spike suddenly up to 80 during a correction. So buying volatility around a low level carries very few risks (if execute correctly) but can potentially give a strong reward in a drawdown. Although we cannot buy the VIX directly, there are several vehicles that move with the VIX. Our preferred VIX-based ETF is VIXM, but probably the ultimate tool for a tech investor that has the capability to buy future contracts is VOLQ (uses the same methodology as VIX) made by CBOE that moves with Nasdaq-100 volatility. To their own saying, a very small allocation can easily save a tech portfolio during a severe correction. If you don’t believe me, VOLQ was under 10 before COVID but jumped to 82.50 at its max. Just think what would have been the effect on a portfolio that would have had a 5% allocation in it. We encourage you to read more about what CBOE has to say about their tools before trying to make this play. On our side, we will here and there play the volatility when this indicator will help us identify that the risk-reward is in our favor. We will alert our members and explain with lot more details what we do and why we do it.
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