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ET on Zacks. Traditionally, smaller investors look to see where institutions are accumulating or distributing shares and try to use their smaller scale to jump in front of the wake—monitoring the VIX isn't so much about institutions buying and selling shares but whether institutions are attempting to hedge their portfolios.
It is important to remember that these large market movers are like ocean liners—they need plenty of time and water to change direction. If institutions think the market is turning bearish, they can't quickly unload the stock. An option contract can be made up of intrinsic and extrinsic value. Intrinsic value is how much stock equity contributes to the option premium, while extrinsic value is the amount of money paid over the stock equity's price.
Extrinsic value consists of factors like time value, which is the amount of premium being paid until expiration, and implied volatility, which is how much more or less an option premium swells or shrinks, depending on the supply and demand for options. These options use such high strike prices and the premiums are so expensive that very few retail investors are willing to use them. If institutions are bearish, they will likely purchase puts as a form of portfolio insurance.
The VIX rises as a result of increased demand for puts but also swells because the put options' demand increase will cause the implied volatility to rise. Like any time of scarcity for any product, the price will move higher because demand drastically outpaces supply. When the VIX is low, look out below! Notice how the VIX established a support area near the point level early on in its existence and returned to it in previous years.
Support and resistance areas have formed over time, even in the trending market of Perhaps the most important tidbit to glean from Figure 1 is the elastic property of implied volatility. A quick analysis of the chart shows that the VIX bounces between a range of approximately the majority of the time but has outliers as low as 10 and as high as Generally speaking, the VIX eventually reverts to the mean.
Understanding this trait is helpful—just as the VIX's contrary nature can help options investors make better decisions. Even after the extreme bearishness of , the VIX moved back within its normal range. If we look at the aforementioned VIX mantra, in context to option investing, we can see what options strategies are best suited for this understanding. This means the market will likely turn bullish and implied volatility will likely move back toward the mean.
The optimal option strategy is to be delta positive and vega negative; i. Delta positive simply means that as stock prices rise so too does the option price, while negative vega translates into a position that benefits from falling implied volatility. When implied volatility is expected to rise, an optimal bearish options strategy is to be delta negative and vega positive i.
This is common when institutions are worried about the market being overbought, while other investors, particularly the retail public, are in a buying or selling frenzy. This "irrational exuberance" can have institutions hedging too early or at the wrong time. While institutions may be wrong, they aren't wrong for very long; therefore, a decoupling should be considered a warning that the market trend is setting up to reverse. The VIX is a contrarian indicator that not only helps investors look for tops, bottoms, and lulls in the trend but allows them to get an idea of large market players' sentiment.
This is not only helpful when preparing for trend changes but also when investors are determining which option hedging strategy is best for their portfolio. Cboe Exchange. State Street Global Advisors.
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VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P index options. The S&P has fallen to a new low over the past month while the VIX has remained subdued below Some investors are looking for a surge in. VIX | A complete CBOE Volatility Index index overview by MarketWatch. View stock market news, stock market data and trading information.