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.
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.
Trade VIX Volatility Index - VIX CFD
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.
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. When it comes to hedging extreme downside risk, trading VIX CFDs makes the best case for hedging when compared to other options.
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. In case when the VIX index is high, you can consider placing a short position on the VIX to profit from its potential downside movement. It can be easily done with CFDs, as contracts for difference allow you to profit from both up and downward price movement.
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.