than being talked about? Not being talked
about! That double-edged popularity sword
is true for teenagers, celebrities, and you
guessed it—volatility (“vol”). For years, vol
was something you read about in dry financial textbooks or heard about from crusty
old traders. And that was unfortunate. Because “vol” has always been an important
tool when it comes to trading, especially for
Yet, as vol became more popular, particularly the CBOE Volatility Index (VIX), and
more people gossiped about it, sure enough,
mean rumors started circulating. TV pundits
were saying things like, “The VIX didn’t tell
me when the market would crash! It’s useless!” Or articles warned investors to shun
the VIX, which apparently was to blame for
NOT SO FAST
Though it seems like vol can’t catch any good
press, there’s hope. Consider four things you
might hear about vol that aren’t necessarily
true—myths, if you will, that should be de-
bunked and replaced with facts.
Selloffs are bad when you’re long stocks.
Those who complain about the VIX often
have a vested interest in the market always
When the market drops, uninformed
pundits may blame the VIX. True, it can
be hard to understand just what the VIX
is. The formula is a bit complex. But conceptually, the VIX is fairly simple. It’s a
weighted average of the implied volatility
of out-of-the-money (OTM) S&P 500 index
Because VIX derives its value from SPX
options, saying the VIX drove the market
down, for example, would be blaming SPX
options. As market participants (you, me,
hedge funds, etc.) buy and sell SPX options
based on how big or small potential SPX
price changes might be in the future, it pushes the values of those O TM SPX options
up and down. When prices go up, all things
being equal, the VIX goes up. When price
goes down, the VIX goes down. So, the VIX
is a kind of indicator as to how much traders
are pushing the SPX options prices up or
down in expectation of what might happen
in the future.
BIG IDEA: WHEN THE POPULARITY OF ANY MARKET
GAUGE CATCHES THE ATTENTION OF THE MEDIA, YOU’LL
NOT ALL BE ACCURATE. CONSIDER A FEW THINGS
ABOUT VOLATILITY THAT MAY NOT BE TRUE.
Vol tells you where the
market is going.
Vol may help you choose
a trading strategy.
The VIX drives the market.
The market drives volatility.
(AND HOW TO DEBUNK THEM)
• PRO / TAKE AWAY: The truth about volatility and what it may really tell a trader.