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What Is The VIX? Is It Important For Trading?

7 October 2009 No Comment

Many people were introduced to the VIX, or the volatily index as many like to call it, over the past year.  During the crash in the fall of 2008, the VIX rose to insanely high levels.  So, what is it?  Should you pay attention to it?

According to Wikipedia:

VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. A high value corresponds to a more volatile market and therefore more costly options, which can be used to defray risk from this volatility by selling options. Often referred to as the fear index, it represents one measure of the market’s expectation of volatility over the next 30 day period.

The VIX goes up and down based on options activity. When people buy (or sell) options, there is a premium involved. The lower the premiums, typically the lower the volatility. When premiums are high, you can expect more volatility. One way of looking at this is that when people anticipate volatility, they are willing to pay more for insurance (the premiums).

The other important point is that high volatility doesn’t necessarily mean the market is heading lower. It can also mean the market is heading higher. For example, if investors are anticipating a large move higher in the markets, they will be willing to pay more for call options thus raising the volatility.

While most investors don’t need to pay attention to the VIX, it is important to understand what it means.  If you watch CNBC, especially shows such as Fast Money, you will hear the VIX mentioned often.

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