The VIX - The Fear Barometer of Wall Street

The CBOE Volatility Index, or VIX for short, is an important indicator for market participants, reflecting the nervousness of the U.S. stock market. Therefore, the index is often used by investors and the financial press to assess the current situation on Wall Street. The VIX measures the expected volatility of the S&P 500 Index (SPX) over the next 30 days. Despite the tense geopolitical situation and difficult economic conditions, the index is as low as it was before the start of the Corona pandemic in early 2020. Does this present an opportunity for investors?

In the financial world, the term "volatility" refers to the price fluctuations of a security. The higher the volatility, the greater the fluctuations; the lower, the weaker. Volatility is therefore an important indicator for market participants to assess the risk of various financial securities. In principle, volatility can be measured in two ways. On the one hand, the volatility of a financial instrument can be calculated from historical time series to find out how strongly the price fluctuated in the past. This is possible with the help of simple statistical calculations, but only provides information about the volatility realized in the past. And as is so often the case, the same applies here: Past performance is not a reliable indicator of future performance.

Another way to determine the volatility of a financial instrument is based on the options traded on it. To determine the price of an option, one needs a number of input factors, such as the price of the underlying, its expected volatility, the remaining term to maturity and the interest rate level. If, on the other hand, one has already given the price of the option or is observing it on the market, one can, in reverse, derive from it the volatility expected by market participants and thus obtain a kind of forecast for the future. This latter method is also used by the Chicago Board Options Exchange (CBOE) to calculate the level of the VIX. The aim of the index is to measure the market's expected volatility of the S&P 500 Index over the next 30 days. For this purpose, the current market prices of call and put options on the S&P 500 with such a maturity are used.

This autumn, the VIX was it at its lowest less than 13 points (September) and thus at a thoroughly low level, which has not been reached since the beginning of 2020. By way of comparison, in March 2020, the index shot up to over 85 points within a very short period of time, when the S&P 500 crashed by around 35 percent in the face of the Corona pandemic. This illustrates that, as a rule, strong corrections in the S&P 500 are accompanied by increased expected volatility and thus a higher index level. In the financial crisis of 2008, the VIX even rose to almost 90 points, which is the all-time high to date.

Currently, the VIX is hovering between 16 and 20 points (16.10.2023). While we are certainly not currently in the midst of a global financial crisis like the one in 2008, and while the pandemic is now behind us, the current geopolitical turmoil and economic challenges raise the question of why the VIX is currently quoted at such levels. According to US investment bank Goldman Sachs, economic risks and seasonal factors can push the fear barometer upwards. On the economic side, the persistent inflation, which has also been a problem for the US Federal Reserve for some time, plays a role. Furthermore, Goldman Sachs observes in historical data a tendency for volatility to increase between August and October, which could be due to an increase in trading activity after the summer break. Nevertheless, these factors do not necessarily lead to an increase in the VIX.

VIX, one year daily chart

VIX, five year weekly chart

Vontobel currently offers Bull & Bear certificates on CBOE VIX futures. VIX Futures are forward contracts on the index described above. For short-term oriented investors who want to trade intraday on the VIX Future, Bull & Bear certificates are ideal. This makes it possible to participate in the fluctuations of the futures with a constant leverage during the day. Investors can choose from whole-number factors ranging from minus 4 to plus 4. However, Bull & Bear certificates are not suitable for longer-term investment due to their path dependence. In addition to the risk of price fluctuations, investors should be aware of the potential losses that may occur, particularly for this product, in the event of a rollover of the underlying asset.