What does VIX tell us about the Stock Market?

VIX tells us a lot about the stock market

VIX tells us a lot about the stock market.  Does it tell us if we are going to make money today or in the future?  No.  Does it tell us where the stock market is going?  Sometimes, but not the way one might think.  VIX tells us about the pulse of the Stock Market.  The Cboe markets it as the “Fear Gauge” but I like to think of it more as the “blood pressure” of the market.  Is the blood pressure low or is the blood pressure high?  Let’s separate the two most important things about VIX.

VIX tells us about 30 Day SPX option implied volatility

VIX tells us about options on the SPX.  Not the NASDAQ and not the RUT. Specifically VIX tells us about SPX implied volatility on options 30 days out from now.  The options run a range from 23 to 37 days out depending on where we are in the day of the week.  The Cboe uses Weeklys in the SPX that far out so they can settle their Weekly VIX options 4 times a month.  VIX does not look at options expiring this week in the SPX.  There can and does exist a disconnect between volatility expiring this week in the SPX and volatility settling 4 weeks from now.  To trade VIX is to trade the blood pressure of the stock market 30 days hence.

Charts by CBOE Livevol

 VIX moves with the SPX

The second big component of VIX is how it is weighted.  One can check out the paper on VIX construction but it is has a square in the Vega component that values the higher Vega in the puts over the calls since SPX skew works that way.  This means VIX should rally when the SPX falls even if IV per strike is dead flat.  This also means that VIX should drop as SPX rallies even if the IV stays dead flat.  VIX can easily accelerate or decelerate once per strike volatility starts to move in SPX 30 days out.

VIX settlement today

VIX cash settled 12.35 this morning, the symbol is VRO for weekly settlement, and closed 13.58.  According to the above paragraph VIX should drop if SPX rallies. It did for most of today but settle higher as SPX returned to unchanged.  That is a real rise in VIX not just a trip up the skew curve.  The 30 day volatility got a little life pumped back into, maybe China Trade or FOMC or both.  With those issues hanging we could not get another 6 month low in VIX like Friday.  If the Fed and Chinese play nice, 30 day volatility  should go sub-12%.  I think VIX strangles are too cheap here.

If you want to see how to structure VIX trades based on how the product works, take our VIX Made Easy Class here.  Send me a note at andrew@optionpit.com saying you saw this blog and I will throw in VXX Made Easy for 50% off too.

Disclosure: VIX, SPX positions

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