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Trading with the VIX: how to trade volatility index in rising global uncertainty

By Capital.com Research Team

11:36, 1 November 2019

trading with the vix

How to invest in VIX? In periods of high global economic uncertainty like today, the markets tend to be extremely volatile. Volatility is negatively correlated to stock market returns which means that it increases when returns decline and vice versa. For a balanced portfolio, traders must include an asset that is positively correlated with volatility. 

The CBOE Volatility Index (VIX) measures the market sentiment on volatility. As a result, it gains the most during periods of uncertainty and high volatility. The VIX uses the S&P 500 Index (SPX) options to forecast volatility for the next 30 days. Trading with the VIX involves buying products that track the volatility index. 

A brief history of VIX

Volatility indices were first proposed in 1989 by two researchers, Menachem Brenner and Dan Galai. The duo recommended the volatility index to be named Sigma and to be updated frequently and used as a derivative for futures and options. 

In 1992, the Chicago Board Options Exchange (CBOE) engaged a consultant by the name of Bob Whaley to compute the values for stock market volatility using the approach proposed by Brenner and Galai. Whaley used data series in the index options market to calculate daily VIX levels from January 1986 to May 1992. 

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VIX correlation with the stock market 

Investors tend to buy options to cover their positions when they are uncertain about the future.  This drives the options premiums up and, subsequently, the implied volatility. The rise in implied volatility creates more uncertainty hence triggering a stock sell-off and a slowdown in buying.

How to trade with the VIX

As mentioned above, the best way to trade the VIX is by trading instruments that track the volatility index. These include Exchange Traded Notes (ETNs) and VIX Futures and Options. 

ETNs enable traders to trade instruments that are designed to replicate specific target indices. For instance, VIX ETNs consists of a pool of rolling VIX futures contracts. When compared to other derivatives, ETNs are easily accessible and cheaper to trade. 

VIX Futures and Options, on the other hand, are best suited for sophisticated traders. These instruments are highly leveraged and therefore offer a more significant earning potential. However, they require higher commissions than equity trades. Moreover, VIX futures need traders to maintain a specific margin.

VIX trading is also accessible through CFDs offered by select brokers. This is probably the easiest and most easily accessible way of trading the VIX profit from volatility. 

Gold

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Long position overnight fee -0.0188%
Short position overnight fee 0.0106%
Overnight fee time 21:00 (UTC)
Spread 0.80

ETH/USD

3,540.34 Price
-0.760% 1D Chg, %
Long position overnight fee -0.0616%
Short position overnight fee 0.0137%
Overnight fee time 21:00 (UTC)
Spread 6.00

BTC/USD

69,992.70 Price
-1.140% 1D Chg, %
Long position overnight fee -0.0616%
Short position overnight fee 0.0137%
Overnight fee time 21:00 (UTC)
Spread 106.00

XRP/USD

0.62 Price
-2.400% 1D Chg, %
Long position overnight fee -0.0753%
Short position overnight fee 0.0069%
Overnight fee time 21:00 (UTC)
Spread 0.01168

How to trade VIX index? Examples of VIX related instruments

The most-traded VIX ETFs include the iPath S&P 500 VIX Short-Term Futures ETN (VXX) and VelocityShares Daily Inverse VIX Short-Term ETN (XIV). The VXX was launched in 2009 to enable investors to bet on the size swings in the S&P 500 index (SPX). Until its maturity early this year, the instrument has been popular with both hedge fund managers and individual investors. 

In the place of VXX is another listing known as the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXXB), expected to mature on January 23, 2048.

According to Seeking Alpha, the VXXB is essentially indistinguishable from the VXX.

VelocityShares Daily Inverse VIX Short-Term ETN (XIV), on the other hand, was issued in the US by Credit Suisse AG (Nassau Branch). The Note offers investors a cash payment at the maturity date based on the performance of the underlying asset, which is the S&P 500 VIX Short-Term Futures Index.

Credit Suisse liquidated this Note in February 2018 after it lost more than 80 per cent of its value in after-hours trade. There is a high-risk, high-return alternative to XIV known as VelocityShares Daily two-times VIX Short-Term ETN (ARCA: TVIX). This ETN tracks an index of futures contracts on the S&P 500 VIX short term Futures Index with a leverage of 200 per cent on the volatility moves. 

VIX instruments for portfolio hedging

The best way to hedge a portfolio against volatility is to invest in instruments that track the VIX volatility index. 

Negative correlation between the VIX index and the stock market presupposes that investors can either use it as a hedging tool for their stock portfolios or as an effective means to gain profit from increased volatility. 

Bottom line

The VIX instruments provide a perfect opportunity to profit from implied volatility and shield a portfolio from the sell-off that results from market uncertainty. Can you invest in VIX? As mentioned above, it is not possible to invest in VIX directly. However, you can always choose a trading instrument that best suits your needs. 

Markets in this article

VIX
Volatility Index
13.68 USD
0.27 +2.040%

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The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
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