A market spooked by a variety of factors ranging from Federal Reserve rate hikes to possible stagflation and a potential recession has pushed stocks to particularly volatile levels.
The Chicago Board Options Exchange’s CBOE Volatility Index, commonly referred to as the VIX, hit a high of 31.98 on May 5.
This spike recorded growing market turmoil as investors tried to reconcile key data indicators with a broader economic horizon.
The VIX pared those gains to then rest around 20% at 30.27 as the market headed into the final two hours of trading.
The all-time high for the VIX was 82.69 on March 16, 2020, when the onset of the pandemic caused investors to take radically different approaches to an economic environment that was changing by the minute.
Before that, its previous peak was at the start of the Great Recession, when it reached 80.86 on November 20, 2008.
What does volatility mean?
Market watchers usually follow the VIX to see market volatility, to understand how anxious investors and traders are becoming.
Simply put, it’s a mathematical prediction of how many stocks measured by the S&P 500 Index will move and change over the next year.
The easiest way to measure this is to compare the number of options bought versus the number of call options placed.
The more put options placed, the higher the volatility. The more call options placed, the lower the volatility.
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From there, investors can understand the likelihood of the market heading into worried or even panicked territory.
The Street offers you a brief tutorial on how to understand why volatility matters.
“Volatility is the degree to which a security (or an index, or the market as a whole) varies in price or value over a given time period,” we explain.
“Volatility refers to both the frequency with which a security changes price and the severity with which it changes price.”
Why should you watch the VIX?
Understanding how and why the VIX moves is a great way to learn how the market might react in the future.
It also gives investors a better idea of the type of market environment they could be getting into.
If you are a conservative long-term investor, you may want to steer clear of opportunities created by volatile conditions – or you can just ignore them and do nothing, as day-to-day fluctuations don’t matter. if you are into something for the long haul.
“Generally, the more volatile a security, the riskier an investment,” says The Street. “That being said, more volatile securities can also offer more substantial returns.”
If you’re looking to make real-time money and understand how the VIX works, you might want to take new opportunities that arise in the margins, understanding them as time-limited opportunities.
To do this, you need to look at the percentages of the VIX.
“Although the VIX is not expressed as a percentage, it should be understood as one. A VIX of 22 translates to an implied volatility of 22% on the SPX,” reads our VIX tutorial.
“This means that the index has a 66.7% chance (that’s one standard deviation, statistically speaking) of trading within a range of 22% above or below its current level, over the next year.”