A market spooked by a variety of factors ranging from Federal Reserve rates hikes, possible stagflation and potential recession has pushed stocks into notably volatile levels.
The Chicago Board Options Exchange’s CBOE Volatility Index, popularly called the VIX, hit a high of 31.98 on May 5.
That spike registered the market’s growing unrest as investors attempted to square key data indicators with a larger economic horizon.
The VIX pared back those gains to then rest at around 20% at 30.27 as the market headed in the final two hours of trade.
The VIX’s all-time high was on 82.69 on March 16, 2020, when the beginning of the pandemic pushed investors into radically different approaches to an economic environment that was changing by the minute.
Prior to that, its previous high was at the beginning of the Great Recession, when it hit 80.86 on Nov. 20, 2008.
What Does Volatility Mean?
Market watchers typically follow the VIX to see how much volatility is in the market, as a way to understand how anxious investors and traders are becoming.
In layman’s terms, it’s a mathematical prediction of how much stocks measured by the S&P 500 Index will move and change over the next year.
The easiest way to measure that is to look at how many options are being bought versus how many call options are being placed.
The more put options placed, the higher the volatility. The more call options placed, the lower the volatility.
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From that, investors can understand how likely the market is to be headed into either concerned or even panicked territory.
The Street has you covered with a brief tutorial on how to understand why volatility matters.
“Volatility is the degree to which a security (or an index, or the market at large) varies in price or value over the course of a particular period of time,” we explain.
“Volatility refers to both the frequency with which a security changes in price and the severity with which it changes in price.”
Why Should You Watch the VIX?
Understanding how and why the VIX moves is a great way to learn how the market could react in the future.
It also gives investors a better grip on what kind of market environment they might be jumping into.
If you are a conservative, long-term investors, you might want to stay away from opportunities created by volatile conditions — or you may just ignore them and do nothing, because day-to-day fluctuations don’t matter if you’re in something for the long haul.
“Typically, the more volatile a security is, the riskier of an investment it is,” The Street explains. “That being said, more volatile securities may also offer more substantial returns.”
If you are looking to make money in real-time conditions and understand how the VIX works, you might want to grab new opportunities arising in the margins, understanding them as limited time only chances.
In order to do that, you need to watch the VIX’s percentages.
“Although the VIX isn’t expressed as a percentage, it should be understood as one. A VIX of 22 translates to implied volatility of 22% on the SPX,” our VIX tutorial reads.
“This means that the index has a 66.7% probability (that being one standard deviation, statistically speaking) of trading within a range 22% higher than — or lower than — its current level, over the next year.”