The VIX and a Unique Way To Trade It

The VIX and a Unique Way To Trade It

VIX is a real time measure of the market’s expectation of the annualized volatility of the S & P 500 over the next 30 days.  It is the market’s current, best estimate of the magnitude of the 30-day price movement of the Index expressed as an annual percentage.  At the time of this writing, the VIX is about 22 which implies a one standard deviation move in the price of the Index of a little more than 6%.  If the Index is currently trading at 4,500, the market expects about 67% chance that the Index will move within +/- 270 points over the next 30 days. (The calculation is a little complex, so this is just an estimate).  The VIX is a one size fits all indication of the risk or stress in the market: the higher the VIX, the greater the expected move, the higher the risk.  If you watch the VIX over time, it will tend to decrease during market rallies, indicating lower fear and concern, and increase during downtrends, indicating increased fear and worry.

How is the VIX Determined?

The calculation of the VIX involves some pretty complex math which is beyond the scope of this write-up.  The VIX is based on the implied volatility suggested by the pricing of SPX options.  Since the VIX represents the 30 day annualize expected volatility, SPX out of the money put and call options with more than 23 days and less than 37 days to expiration (so an average of 30 days) are used.  The VIX represents the weighted average implied volatility priced into these SPX options.

What Does the VIX Term Structure Tell Us

The VIX term structure is the relationship between volatility (as estimated using the VIX) and time.  Although the commonly discussed VIX is based on a 30 days, the VIX is calculated for a series of time periods: 

  • 9-day VIX: VIX9D
  • 23-day VIX: VIN (approximately 23 days)
  • 37-day VIX: VIF (approximately 37 days)
  • 3-month VIX: VIX3M
  • 6-month VIX: VIX6M
  • 1-year VIX: VIX1Y

Here’s what the current VIX term structure looks like:

Notice that as we move further out in time, volatility is higher – so the term structure is upward sloping.  This makes sense – the further out in time you go, the greater the risk of a significant move in the markets so the higher the volatility.  The term structure is upward sloping (called contango) most of the time, usually indicative of a bullish tone to the markets.

Now take a look at the term structure in late January 2022:

What do you notice?  It’s downward sloping (called backwardation)– the near-term volatility is higher than the longer-term volatility indicating there is much greater market risk in the short term.  This term structure is generally associate with corrective or bearish markets.

How to Trade the VIX – Masters In Trading VIX Trading System

Now that we’re familiar with the VIX term structure, how do we use it to find and manage trades? A common approach is to buy calls on the VIX to express a more bearish market view, expecting the VIX to increase or buy puts on the VIX to express a more bullish market view, expecting the VIX to decrease.  A much better approach is the Masters In Trading VIX Trading System.  VIX Trading System uses a proprietary approach that has 100% success, yes 100%, since 2013.  The System analyzes the movement of the VIX and looks for specific conditions to issue a buy signal on the S & P 500.  In general, the System is looking for a spike in the VIX, then a pull back and based on the term structure, will issue a buy signal for the Index.  Here are the SPX buy signals for the last 3 years assuming SPX options are used for the trade and held for a 100-point increase in the Index:

Be creative in determining your long exposure: use options, futures, or stock; use the S & P, the NASDAQ, the Russell, etc.  Since the signal requires a certain set of conditions, they may occur more or less frequently; the key starting point is a spike in the VIX.  The SPX may initially retrace but the signal always wins!

Check Out Master in Trading VIX Trading System

Check out VIX Trading System.  As always, paper trade, paper trade, paper trade until you’re completely comfortable entering a trade and managing anything that may and will happen!

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