The VIX Index: Why it can pay to see what it’s up to

Julie Brownlee, Fsp Invest, 03 Jul. 2014

Tags: vix index, vix, volatility index, what is the vix, how to read the vix, put options, stock market

All investors would love a crystal ball. If only you knew what was ahead, you could make a killing on the stock market. There may not be a market crystal ball, but there is an index that’s worth checking out: The VIX Index. So what does this index tell you? And how can you use it? Read on to find out…

What is the VIX Index?

The VIX Index is an index which measures how volatile investors think the market is. In the VIX’s case, the market is the S&P 500 in the US.

Looking at volatility can be a good way of working out what’s ahead over the short-term in the market.

Volatility can be very hard to measure, David Thornton in Penny Sleuth explains. But the VIX gives a number. And this number can show how nervous people are feeling about the market.

How does the VIX Index work?

The VIX Index measures how cheap or expensive a put option is. When share prices start to climb, some investors start to think a turn in the market is on its way and demand for this put option rises.

Demand falls for this put option when share prices are lower. This means less people are looking to protect themselves against a fall in the market.

If you think the market is in for a big dip, you could just sell all your shares. But if you get your timing wrong, you’ve sold your shares while they continue to climb in value.

The alternative is to buy put options. For a premium, you protect yourself against losses for a certain period of time.

If the market falls, you’ll offset your losses from gains from the put option. If the market continues to rise, then the option expires and all you’ve lost is the cost of the premium for the put option.

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How to read the VIX Index

Basically the higher the VIX Index reading, the higher the expected volatility and the cost of put options. A VIX reading over 30 usually indicates high volatility. A reading under 20 usually means less volatile times.

If you want to find out the current VIX reading, just Google ‘volatility index quote’.

So there you have it, why it can pay to see what the VIX Index is up to.

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