The CBOE VIX Index, often called the 'fear gauge', has caught the attention of investors worldwide today as market jitters continue to mount.
The VIX is short for the Chicago Board of Options Volatility Index.
Used as a tool to gauge expected volatility in the US stock market, the VIX can signal turbulence ahead, helping investors understand potential shifts in market sentiment.
And now, with the week's big event behind us – the US Presidential Election on Wednesday Australian time – chatters of the VIX are making their way around investor circles. Let's take a closer look.
What is the VIX index?
The VIX Index measures the 30-day volatility of the S&P 500 Index (SP: .INX), considered the US equity benchmark. It doesn't focus on price. More precisely, it measures the expectations of future volatility on the S&P 500 and ignores past fluctuations.
In that vein, the VIX Index serves as a forward-looking gauge of investor sentiment.
When market expectations grow shaky, the VIX often spikes. Conversely, a low VIX typically reflects market calm or optimism.
This is one reason why it is also called the "fear and greed index" among investors. A high VIX equals fear. A low VIX equals greed.
How does it measure all of this?
CBOE constructs the index by analysing call and put option prices on the S&P 500, with expiration dates between 23 and 37 days out.
Options prices tend to rise when investors grow concerned, which in turn raises the VIX. Therefore, the index often moves in the opposite direction of stock prices.
While you can't directly invest in the VIX Index, it's possible to gain exposure through futures contracts or exchange-traded funds (ETFs) that aim to track the VIX.
VIX Index levels and what they mean
Here's a general guide to what different VIX levels indicate:
- 0-15: Low, suggesting market optimism.
- 15-20: Moderate, reflecting normal market conditions.
- 20-25: Medium, suggesting growing market concerns.
- 25-30: High, indicating a volatile environment.
- 30+: Extremely high, signalling severe turbulence.
For example, the VIX spiked to 79 during the 2008 financial crisis. It hit a record 82.69 in March 2020 as COVID-19 fears were rampant. In contrast, during calmer periods like 2013, the VIX remained as low as 12.
At the time of writing, the index is sitting above 16, putting it in the 'moderate' category of fear.
What's up with the VIX today?
The index plunged overnight after confirmation Donald Trump had won the US Presidential election, triggering a wave of inflows to US equity markets.
So-called 'quant' funds, which bet on specific rules and data on the VIX, are expected to pile into stocks after the result.
About US$50 billion of inflows into US shares could take place over the coming month says investment bank Nomura, quoted by The Australian Financial Review.
The bank also projects a total of US$110 billion into the same markets by January next year.
What's important is that the VIX level has dropped following the US election results, potentially signalling a more optimistic tone in markets and a more risk-on attitude.
In saying that, it's still early days.
While the US markets closed higher overnight, the optimism didn't permeate the ASX, with the S&P/ASX 200 index (ASX: XJO) down 0.4% at the time of writing.
Foolish takeaway
The VIX Index remains a critical indicator for gauging market sentiment, particularly in times of uncertainty.
Measuring 'fear and greed' on Wall Street, the index dropped overnight, potentially signalling the market's optimism.
Time will tell what happens from here.
