The Cboe Volatility Index (VIX) is an indicator used to measure the level of volatility in financial markets, particularly in stocks listed on the United States stock exchange. This indicator is known as the “Fear Index” because its value often indicates uncertainty or fear in the market.
VIX was first introduced in 1993 by the Chicago Board Options Exchange (CBOE), and has become one of the most widely used indicators by investors and traders worldwide. The VIX is calculated based on the price of stock options traded on the CBOE, which reflects the expected future market volatility.
Along with the development of technology and financial trading, VIX is now accessible to anyone through an online trading platform, so that more and more investors and traders are using it as a tool for market analysis and investment risk management.
In this article, we will discuss how the VIX works, interpretation of the value of the VIX, its use in investing, criticisms of the VIX, and conclusions about the benefits of using it in market analysis and investing.
How the VIX Works
The VIX is calculated based on the price of stock options on the S&P 500 stock index, which includes stocks from the top 500 companies in the United States. These stock options are traded for a certain period of time and have a certain strike price. Stock option traders take long (buy) or short (sell) positions in stock options to profit from future stock price movements.
The VIX calculation is performed using a complex mathematical formula, which involves factors such as the price of a stock option, the term of the option, the historical volatility of the market, and the risk-free interest rate. In practice, VIX is calculated using stock options that have a maturity of 30 days and are calculated in real-time every 15 seconds.
The VIX value obtained indicates the level of market volatility in the calculated time period. In general, when the VIX increases, it indicates an increase in market volatility, which is usually caused by factors such as economic or geopolitical uncertainties. Conversely, when the VIX declines, it indicates a decrease in market volatility and a steady trend of the market.
The VIX can also provide indications about the direction of the market movement going forward. When the VIX value is high, it can indicate that the market is experiencing high uncertainty and there is a possibility of a decline in the stock price in the future. Conversely, when the VIX value is low, it indicates that the market is stable and there is a possibility of an increase in the stock price in the future.
VIX Value Interpretation
The interpretation of VIX values may vary depending on the prevailing market context. In general, a high VIX value indicates uncertainty or fear in the market, while a low VIX value indicates a stable market trend.
For reference, here are some common interpretations of VIX values:
VIX score below 20: The market is stable and there is a possibility of an increase in the share price.
VIX score between 20-30: The market is experiencing uncertainty, but has not yet reached high levels. There is a possibility of a decrease in the share price, but not significantly.
VIX score between 30-40: The market is experiencing high uncertainty and there is fear in the market. There is a possibility of a significant decline in the share price.
VIX score above 40: The market is experiencing very high uncertainty and there is a lot of fear in the market. There is a possibility of a drastic decline in the stock price.
Use of VIX in Investment
The Cboe Volatility Index (VIX) has a variety of uses in investing, especially in market analysis and investment risk management. The following are some of the uses of VIX in investing:
1. Market and Investment Analysis Tool
VIX can be used as a market and investment analysis tool that is useful for monitoring the level of volatility in the stock market. This indicator can help investors and traders understand market conditions, and make better and more effective investment decisions.
For example, a high VIX value can be a signal to investors and traders that there is uncertainty in the market, so they can decide to reduce investment risk by selling shares or using other security instruments. Conversely, a low VIX value can be a signal for investors and traders to increase their investment risk by buying stocks or other financial instruments.
2. Investment Risk Management
VIX can be used as an effective investment risk management tool, especially in reducing investment risk when the market is unstable. In this case, investors can use the VIX value as a guide to determine the level of risk that is safe and appropriate for their investment.
For example, if the value of the VIX rises above a certain level, investors can reduce investment risk by moving their funds to safer financial instruments, such as bonds or deposits. Conversely, if the value of the VIX falls below a certain level, investors can increase their investment risk by purchasing stocks or other financial instruments.
3. Stock Options Trading Strategy
The VIX can also be used as a tool to develop an effective stock options trading strategy. Stock options are financial instruments that give the right to buy or sell shares at a specified price in the future.
In the stock options trading strategy, VIX can be used to determine the level of market volatility, so that investors can develop strategies according to market conditions. For example, if the VIX value is high, investors may choose stock options that give the right to sell shares at a certain price (put option), because there is a possibility of a significant decrease in the share price.
Criticism of the VIX
Although the Cboe Volatility Index (VIX) has been widely used in market and investment analysis, the VIX also has several criticisms and weaknesses that need to be considered, including:
1. Frequently leveled criticism of the VIX
One frequent criticism of the VIX is that it only measures stock market volatility in the short term. This can make the VIX inaccurate in predicting long-term market movements, as VIX values only reflect short-term volatility.
In addition, the VIX can also be inaccurate when market conditions are unstable or abnormal, such as during an unexpected event or financial crisis. In these conditions, the VIX may provide wrong or inaccurate signals in predicting market movements.
2. Weaknesses and limitations of using VIX in market analysis
Apart from the criticisms leveled against the VIX, there are also some disadvantages and limitations of using VIX in market analysis. Some of these weaknesses and limitations include:
* VIX only measures stock market volatility, so it cannot be used as a complete indicator in market analysis. Investors and traders need to use market analysis tools which are more comprehensive and cover other aspects of the market, such as company fundamentals and macroeconomic factors.
* The VIX only focuses on the stock market in the United States, so it doesn’t cover stock markets around the world. This can make the VIX inaccurate in predicting global market movements.
* VIX only provides an overview of stock market volatility, and does not provide specific information about stock price movements. Therefore, investors and traders need to use other market analysis tools to get more detailed information about stock price movements.
Overall, the Cboe Volatility Index (VIX) is an important indicator in market and investment analysis. The VIX provides an overview of stock market volatility and can be used as a tool to predict short-term market movements. However, the VIX also has its critics and drawbacks that both investors and traders need to consider. Therefore, the use of VIX in investment needs to be done with caution and accompanied by a more comprehensive market analysis. What’s more, investment decision-making needs to be considered carefully based on market conditions that are dynamic and cannot be predicted with certainty.