Friday, May 16, 2008

Volatility Index (VIX)

The Chicago Board Options Exchange Volatility Index (VIX), is a benchmark for options prices in the US. The VIX gauges the cost of insuring against declines in the S&P 500 index. That means it gives a level of bullishness from investors in the US.

If the index is high, investors are foreseeing that S&P index to fall or collapse. Thus investors in US buy options (or like put warrants in Singapore market) to hedge their investment against any correction. If the index is at low level it means that investors are bullish with the market, so there isn't any need to hedge or protect their investment.

The chart below shows the historical trend of VIX since year 1990. You can see that the chart is inversely correlated to the S&P index. During the major crash in year 2000, VIX is at all time high level and during the recent strong bull run from year 2003, VIX is approaching low levels.

Historical VIX chart

If you were to zoom in to the latest VIX chart, you can see currently the index is reaching low level like in Oct 2007. There is negative divergence forming on MACD histogram. That means the VIX is trending downwards. If the VIX can break the support level of 17.5, we can expect it to test price of 15 which is the 200 days moving average. Again cautious investors can always wait till the index reaches a value of 10 to ensure certainty.

Latest weekly VIX chart

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