Above: plotting the VIX against the S&P- in English the volatility index-calculated from near the money option prices,and the SPX which is the index based on the top 500 stocks in the US.
What Does it Mean? Is it Predictive?
I cannot make predicitions and I never will!
However, the VIX may be the closest thing we have to a crystal ball. The green line is the SPX and as can be seen 27th June something big happened- the SPX in 3 days dropped 122 points or 5.8%, while the VIX jumped from roughly 17 to 27. The market then turns back up,the VIX drops. This is an extreme example of how the market gets spooked and volatility smashes up. How can we use this? If you look at the correlation between the two metrics,there are times when VIX gets to extremes as does the market-and if you are patient you can use this to trade. This year has been horrible for volatility having had the flattest July and August for decades.
Why Options are so Different
The market hates uncertainty,as it leads to volatility. We love volatility-it makes our strategies work. Because the VIX is mean reverting. But herein lies another problem-what IS a low VIX? Currently……. below 12- but for at least 2 weeks in August it stayed low. Now the smart thinking goes like this- you BUY options when VIX is low, but you know the market will probably drop in order for the VIX to rise, so you want to buy the option that allows you to SELL the underlying(FTSE in our case),and that is why you would be looking to buy PUTS.The Sept 6650 PUT was a buy at 23.5 on 15th August,by the 17th it was 39.5, (68% rise)FTSE had only dropped 1% yet the volatility had spiked up. When the market drops,we profit,but that is only 1% of what we can do.
The UK equivalent to VIX is https://www.google.co.uk/finance?q=VFTSE&ei=IBjOVPhV59nBA4vRgIgK
It’s helpful to look back and see the relationship between market dips and volatility. Nobody seems to get scared when markets rise-this is ironic really,as the higher markets go,the more likely they are to fall. Volatility is way too low and markets are, for my money, not reflecting true conditions-but the world always wallpapers over the cracks,until the crack becomes a chasm,then it’s time to capitalise even more while the dumb money sells at the bottom.
I think historically VIX hasn’t remain so low for a quarter. The VIX cooled down after brexit and since then hasn’t crossed 17!