Wall Street has been extremely turbulent lately, and on Wednesday morning, investors got another case of the jitters. Focusing on all the things that could go wrong in the market, major stock indexes were poised to lose substantial ground when the market opens. In premarket trading Wednesday morning as of 8 a. Stock market volatility levels have been on the rise, and many investors are looking to protect themselves against further declines by looking to the options market. That has some investors looking for ways to profit -- and this morning, they're turning to exchange-traded funds designed to try to track the VIX.
The ETF universe has found ways to invest in nearly anything, and volatility is no exception. This security is designed to track the daily movements in the front month and second month VIX futures contracts. It uses a slightly different methodology in selecting futures contracts to achieve the same goal. EDT Wednesday. Those investors seeking an even larger gain from rising volatility levels can use leveraged volatility ETFs.
Investing in volatility is dangerous. The first thing to keep in mind is that these products are all designed to tie to daily returns, and that makes them less than ideal for long-term investors.
However, the massive returns you can earn if you have perfect timing are tempting. By the end of the year, the ProShares fund had actually dropped back to a net loss after its huge spike.
Because of their big daily moves, volatility ETFs are attractive to short-term traders. Generally speaking, if the VIX index is at 12 or lower, the market is considered to be in a period of low volatility. On the other hand, abnormally high volatility is often seen as anything that is above Alternatively, you can buy and sell VIX options and futures contracts.
As exchange-traded products, you can buy and sell these securities like stocks, greatly simplifying your VIX investing strategy. Before investing in any VIX exchange-traded products, you should understand some of the issues that can come with them. ETNs in particular can be less liquid and more difficult to trade as well as may carry higher fees.
Market professionals rely on a wide variety of data sources and tools to stay on top of the market. The VIX is one the main indicators for understanding when the market is possibly headed for a big move up or down or when it may be ready to quiet down after a period of volatility.
Experts understand what the VIX is telling them through the lens of mean reversion. In finance, mean reversion is a key principle that suggests asset prices generally remain close to their long-term averages. If prices gain a great deal very quickly, or fall very far, very rapidly, the principle of mean reversion suggests they should snap back to their long-term average before long.
When the VIX moves lower, investors may view this as a sign the index is reverting to the mean, with the period of greater volatility soon to end. As an investor, if you see the VIX rising it could be a sign of volatility ahead. You might consider shifting some of your portfolio to assets thought to be less risky, like bonds or money market funds.
Alternatively, you could adjust your asset allocation to cash in recent gains and set aside funds during a down market. On the other hand, during times when the VIX is falling, indicating the possibility of more stability to come in the stock market, it might make more sense to focus on individual stocks or other riskier assets that might fare well during times of growth.
Miranda Marquit has been covering personal finance, investing and business topics for almost 15 years. Miranda is completing her MBA and lives in Idaho, where she enjoys spending time with her son playing board games, travel and the outdoors. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for Bankrate and LendingTree.
Select Region. The price that you choose to buy or sell the underlying market is known as the strike price. To be considered for the VIX index, an option must have an expiry date between 23 and 37 days. The options that qualify for inclusion will be at the money so that they show the general market perception of which strike prices are going to be hit before expiry. This then indicates the wider market sentiment surrounding the direction of the market price.
There is a strong negative correlation between the VIX and stock market returns. Trading volatility is not the equivalent of a market downturn, as it is possible for the market to decline but volatility remain low.
This is why VIX values are quoted as percentage points. For the past several years, if the VIX was trading below 20 then the market was considered to be in a period of stability, while levels of 30 or more indicated high volatility. When the VIX is low, look out below. Instead, you can trade the VIX by using derivative products that are designed to track the price of the volatility index. Note that we price our VIX index in a different way to the rest of our cash index markets.
We follow the method used to derive our undated commodities , by creating a price between the two nearest futures contracts on the underlying market, as these tend to be the most liquid markets.
When you open a position on the VIX, there are two basic positions that you can take: long or short. The position you decide to take will depend on your expectation of volatility levels. Going long on the VIX is a popular position in times of financial instability, when there is a lot of stress and uncertainty in the market.
You could do this by opening a position to buy the VIX. If there was volatility, your prediction would have been correct, and you could take a profit. However, if you had taken a long position and there was no volatility on the market, your position would have suffered a loss. Short-selling volatility is particularly popular when interest rates are low, there is reasonable economic growth and low volatility across financial markets.
You might decide to short volatility with the expectation that the stock market will keep rising and volatility will remain low. However, shorting volatility is inherently risky, as there is the potential for unlimited loss if volatility spikes. Creating a live trading account with IG is a straightforward process. You could be ready to open your first position in minutes with these quick steps:. When the VIX is low, it means there is less market fear, more stability and long-term growth.
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