Want A Better Way To Use The VIX? – The Fear Gauge

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The CBOE Market Volatility Index, more commonly known as the VIX, is misunderstood and misused by most people on Wall Street. Most people think the VIX measures volatility (after all the words “Market Volatility Index” are used in its name) but that is not always the case. Over the years, I have found it does a remarkable job of measuring downside volatility and a poor job of measuring upside volatility. That is why I use the VIX to measure broader sentiment – (specifically fear) much better than just pure market volatility.  

Case Study: Most recently, on Monday, the VIX vaulted 20% and the $SPX fell 1%. On Tuesday, the $SPX enjoyed its best day of the year and rallied a very healthy 1.5%- meanwhile, the VIX fell 11%. Let’s take a look at sentiment during that period. On Monday, fear was extreme, people were calling Putin the next Hitler, rumors were flying that this would become Obama’s Bay of Pigs, etc..etc. On Tuesday, Putin pulled back, Kerry landed in Kiev, and all was better in the world- at least on that day. This is just one recent example but there are countless others that are beyond the scope of this post. So next time you look at the VIX, remember, it measures fear infinitely better than it measures volatility.

Earlier today, my friend Andrew Wilkinson, Chief Market Strategist at $IBKR, sent me this table and note discussing the VIX.

Table – CBOE Volatility index – average annual reading 2006 to March 2014

 

Date

Average

Close

2006

12.81

11.56

2007

17.54

22.50

2008

32.81

40.00

2009

31.45

21.68

2010

22.55

17.75

2011

24.20

23.40

2012

17.80

18.02

2013

14.25

13.72

Jan-14

13.51

14.28

Feb-14

14.07

15.51

Mar-14

14.50

14.35

The latest reading matches the average reading for all of 2013, which was 14.25. Prior to that the average reading for all of 2012 of 17.80 was the least volatile since 2008 and as investors started to see the results of firm central bank action, even if it was uncoordinated.

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