• Traditionally, there’s been an inverse relationship between volatility (vol) and the
price of a stock or index. When the price of
a stock goes up, its vol goes down. When the
price of the stock goes down, its vol goes up.
That’s what most traders believe, anyway.
And it’s largely true.
For example, when you look at the S&P
500 Index (SPX) and its overall vol indicator, the Cboe Volatility Index (VIX), over a
long period, they seem to have an inverse
relationship. Spikes in the VIX usually
occur when the SPX drops sharply, and the
VIX sinks back when the SPX rallies. Remember what the SPX and VIX did in late
2008 and early 2009? The SPX crashed and
the VIX spiked dramatically higher. Over
the last couple of years, as the SPX has rallied, what’s the VIX been doing? It’s been
mostly lower or flat. Also, when the SPX
had its short-lived but dramatic sello;s
during these last few years, the VIX rallied.
HERE’S THE SCOOP
The VIX is based on the prices of SPX options. When the market starts to drop, traders sometimes think the next crash is near
and start bidding up the prices of put options,
which should become much more valuable
if the market does indeed crash. That’s the
logic, anyway, but in fact, it increases the VIX
whether the market ends up crashing or not.
When the market rallies, general complacency sets in. Traders don’t expect any big
moves in the SPX. They may sell SPX calls
and puts because they believe the market
won’t crash and won’t rally too quickly.
Selling options to take advantage of positive
time decay pushes down the prices of SPX
call and put options. That, in turn, drives the
But trader sentiment can be fickle, chang-
ing from one day to the next regardless of
what the SPX is doing. If the SPX is up a little
bit one day, but traders think it might drop
the next, the VIX can go higher. If the SPX
is down a little one day, but
traders think it won’t follow
through on the downside, the
VIX can go lower. As such,
day-to-day moves in the SPX
versus the VIX may not al-
ways correlate. You might see
the SPX up 0.50, for example,
Those small moves in the market are often
considered noise, and most of the time traders
ignore them. Instead, they may focus on what
the market might do when future news or a
financial event arrives. For example, after a
Federal Open Market Committee (FOMC)
meeting, the SPX can move sharply higher or
lower as the market digests the Fed’s report.
So you might see the VIX increase ahead of
the meeting, while the SPX moves up or down
a small amount. In this case, the SPX and VIX
don’t track each other closely. But after the
FOMC meeting, if the news is bearish and
the SPX drops, the VIX could dutifully rally.
If the news is bullish and SPX rallies, the VIX
could drop. With the uncertainty resolved, the
SPX and VIX may resume a more correlated
HOW DO YOU APPLY ALL THIS?
If you’re bullish and the VIX is high after the
market sells o;, consider short, out-of-the-money (O TM) put spreads in an index to
collect a higher credit. On the other hand, if
you’re bullish and the VIX is low, you might
consider long call spreads. If you’re bearish
and the VIX is high, you might consider
short, O TM call spreads, again, to collect a
higher credit. If you’re bearish and the VIX is
low, consider a long put spread or O TM put
The key? Don’t overthink short-term
moves in the VIX vis-à-vis the SPX. Look at
the big picture and consider using an options strategy designed to take advantage of
the VIX.—Words by THOMAS PRESTON
Thomas Preston is not a representative of
TD Ameritrade, Inc. The material, views, and
opinions expressed in this article are solely those
of the author and may not be reflective of those
held by TD Ameritrade, Inc.
For more on the risks of trading and trading
options, see page 38, #1 & 2.
Do Vol and Price Tango? Sort Of.
DOES VOLATILITY AFFECT OPTIONS PRICES? TO
SOME EXTENT, YES. BUT AVOID FOCUSING ON THAT
RELATIONSHIP TO MAP YOUR STRATEGIES.