The VIX, also known as the fear index or fear gauge, is one of the most watched indicators in financial markets. Created by the CBOE, it measures expected volatility in the S&P 500 over the next 30 days. Understanding the VIX can help you gauge market sentiment, time your entries and exits, and manage risk more effectively.
What is the VIX?
The CBOE Volatility Index (VIX) measures the market's expectation of 30-day forward-looking volatility. It is calculated using the implied volatilities of S&P 500 index options. When traders expect large price swings, the VIX rises. When they expect calm markets, the VIX falls.
Key concept: The VIX is often called the fear index because it tends to spike during market selloffs when fear is high. However, it also reflects uncertainty in either direction, not just downside fear.
How the VIX is Calculated
The VIX calculation is complex, but here is the basic concept:
- The CBOE uses a wide range of S&P 500 index options (both puts and calls)
- It calculates the weighted average of implied volatilities across different strike prices
- The result is annualized and expressed as a percentage
- A VIX of 20 suggests the market expects approximately 20% annualized volatility
Converting VIX to Expected Daily Move
To estimate the expected daily move in the S&P 500:
- Divide VIX by 16 (square root of trading days)
- VIX of 16 = approximately 1% expected daily move
- VIX of 32 = approximately 2% expected daily move
- VIX of 48 = approximately 3% expected daily move
Understanding VIX Levels
Low VIX (Below 15)
Low VIX indicates complacency and low expected volatility. While this can persist during bull markets, extremely low VIX often precedes volatility spikes.
Normal VIX (15-20)
This range represents typical market conditions with moderate expected volatility. Neither fear nor complacency dominates.
Elevated VIX (20-30)
Elevated VIX shows increased uncertainty and concern. This is common during market corrections and periods of macro uncertainty.
High VIX (30-40)
High VIX indicates significant fear in the market. This often coincides with sharp selloffs and can signal potential capitulation.
Extreme VIX (Above 40)
Extreme VIX readings occur during market panics and crises. The VIX reached 82 during the 2020 COVID crash and 80 during the 2008 financial crisis.
Historical VIX Extremes
- March 2020 (COVID): VIX peaked at 82.69
- October 2008 (Financial Crisis): VIX hit 80.86
- August 2015 (China Devaluation): VIX spiked to 53
- February 2018 (Volmageddon): VIX jumped to 50
VIX as a Contrarian Indicator
The VIX is most useful as a contrarian tool at extremes:
Extremely High VIX (Above 35-40)
When the VIX spikes to extreme levels, fear is often near its peak. Historically, buying the S&P 500 when VIX is above 35 has produced strong forward returns. This is because extreme fear often marks capitulation.
Extremely Low VIX (Below 12)
When VIX drops to historically low levels, complacency is high and the market may be vulnerable to a volatility spike. While low VIX can persist, it often precedes periods of increased turbulence.
Important: VIX extremes are better for identifying potential turning points than for precise timing. The VIX can stay extreme longer than expected, so always use price action and other signals for entry timing.
Trading Strategies Using VIX
Strategy 1: VIX Spike Buy Signal
Look for buying opportunities when VIX spikes sharply:
- Wait for VIX to spike above 30 (or above 25 in calm markets)
- Look for VIX to start declining from the spike (not just at the peak)
- Enter long positions in the S&P 500 or quality stocks
- Use a defined stop loss below recent lows
Strategy 2: VIX Term Structure Analysis
Compare near-term VIX to longer-term VIX futures:
- Contango (normal): Near-term VIX lower than future VIX - calm markets
- Backwardation: Near-term VIX higher than future VIX - fear spiking, often near bottoms
Strategy 3: VIX Moving Average Crossovers
Apply moving averages to VIX for smoother signals:
- When VIX crosses above its 10-day or 20-day MA, volatility is increasing (caution)
- When VIX crosses below its moving average, volatility is declining (favorable for longs)
VIX Buy Signal Example
The S&P 500 drops 8% over two weeks and VIX spikes from 15 to 35. The VIX peaks at 35 and starts declining, closing below 30 the next day. This declining VIX from a spike level is a potential buy signal for the S&P 500, with a stop below the recent price low.
VIX Products for Trading
Several products allow you to trade VIX-related exposure:
VIX Options and Futures
CBOE VIX options and futures allow direct volatility trading. These are complex products best suited for experienced traders.
VIX ETFs and ETNs
- VXX: Short-term VIX futures ETN (benefits from volatility spikes)
- UVXY: 1.5x leveraged VIX futures ETF
- SVXY: Inverse VIX futures ETF (profits when volatility declines)
Warning: VIX ETFs and ETNs suffer from significant decay due to contango and daily rebalancing. They are designed for short-term trading, not long-term holding. Buy-and-hold investors in these products typically lose money over time.
VIX in Portfolio Management
Beyond trading, VIX can inform portfolio decisions:
- Position sizing: Reduce position sizes when VIX is elevated
- Hedging decisions: Hedges are cheaper when VIX is low
- Cash allocation: Consider raising cash when VIX is extremely low (complacency)
- Rebalancing: VIX spikes can create rebalancing opportunities
Combining VIX with Other Indicators
VIX works best as part of a complete analysis framework:
- Put/Call Ratio: Confirms sentiment extremes
- Market breadth: Shows underlying market health
- Technical support/resistance: Improves entry timing
- Moving averages: Identifies trend context
Common Mistakes to Avoid
- Treating VIX as a timing tool: Use it for context, not precise entries
- Holding VIX ETFs long-term: Contango decay destroys returns
- Ignoring the trend: VIX can stay low for extended periods in bull markets
- Fighting VIX spikes: Do not short volatility into a spike
Track Your Trades Across Market Conditions
Pro Trader Dashboard helps you monitor how your portfolio performs in different volatility environments. See which strategies work best in high VIX versus low VIX markets and optimize your approach.
Summary
The VIX is an essential tool for understanding market sentiment and expected volatility. While it should not be used in isolation, extreme VIX readings can signal potential turning points and inform your trading decisions. Use high VIX readings as potential buying opportunities and low VIX as a caution sign. Always combine VIX analysis with price action and other indicators for best results.
Continue learning about sentiment indicators with our Put/Call Ratio guide or explore the Fear and Greed Index.