So I was thinking in preparation for writing something; what is the minimum a retail trader needs to know about the Vix? What is the shortest amount of blog posting I can do that will get across to a rookie trader the essence of the Vix and how this fits together with trading? I suppose the answer starts with talking about where the Vix came from and what it is as well as where I came from and who I am very quickly. So here goes :).
The Vix appeared in the late 1990s and came out of the CBOE. The CBOE is a trading floor in Chicago, Illinois in the US. The trading floor was most active in the late 1980s and 1990s. Now it is closed due to the Covid thing but when it reopens around June 1st? it will be opening as it closed a month ago with the Vix pit and the SPX pit being the main products. I was a trader at the CBOE from 1994-2003. Back then it had around 50 different "pits" or spots where people stood and used the open outcry system to trade stock and index options. There were around 50 small pits with somewhere between 3 and 20 stocks in each pit and each pit trading options on these products with different expiries. There were also some index pits, the biggest of which was the OEX pit with the SPX pit a close second and the NDX pit really not distinguishable in size from normal equity pits. All those pits are gone now from the CBOE and it is now a big empty area with the Vix and SPX trading areas at one end.
Back then in the late 1990s we became aware of the Vix as a number. It was like an indicator. As time went by however, futures on the Vix were created. The published number with the name Vix associated with it is based on a formula which samples a strip of option prices in the SPX. The SPX is an index of top US publicly traded companies. As option trades we have a way of comparing option prices of one stock to another. We talk about vol... So we may say that stock a has a vol of 55 average and stock b has a vol of 70 average. Indices also have a vol number which is usually way lower than an individual stock. This sort of makes sense because the movement of several stocks together is going to be less than a single stock as several of the stocks will offset each other.
Think of the Vix as the vol level of the SPX. It is actually more accurately the implied volatility of options on the Spx. The Vix is the price level of options in the Spx 30 days out in time. So if you were to pull up a screen with Spx options on it you would find that the level of prices on Spx options that expire around 30 days from now will correspond to the current price of the Vix.
Why do you care? Well knowing the level of the Vix and following it day to day is going to give you useful information about the state of the financial markets. The Vix generally is higher when the markets are down and people are concerned and generally higher when markets are calm. This is why it is sometimes called the "fear gauge." A key takeaway is that the Vix is just a number that comes out of this formula. It is not shares of anything. There is no direct way to trade it. As previously stated there are Vix futures. These trade freely and although relate to the Vix, they do so in a complicated way. We use the Vix term structure to describe what is going on with them at any one point in time.
Vix futures however can be complex to trade and thus trading the Vix should occupy a separate space from considering the Vix and an indicator and a way to help you profit when trading equities (stocks) or options on stocks. For the purpose of this series we are going to stick to the Vix as an indicator and to ways we can use it to enhance our trading of other products.
So there you go. That is a start.. More to come.......
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