Using the VIX Index to Enhance Your Trading
Using the VIX index gives you a clear trading advantage. The VIX acts like a barometer for the fear and greed that the broad market base of market players are feeling and as such, can be used as a tool to help you get a feel for where the market is likely to go. It can also guide binary options traders who are interested in trading the S&P 500 index. The VIX is a measure of the implied volatility of the at-the-money calls and puts of the S&P 500 index, and reflects the level of premium that needs to be paid to purchase at-the-money options.
Implied volatility is an estimate of the distance the S&P 500 index will move over a certain period on an annualized basis. Since the VIX is a measure of market implied volatility, this is relevant. For example, a VIX reading of 13.98% means that market participants believe that over the next 30 day period, the S&P 500 index will move an annualized 13.98%, which translates to 1.17% over the next 30 days.
Using the VIX index effectively works like this. The VIX will generally move higher when the market is in fear of impending reversals, as investors will pay higher put option premiums for protection against downward price moves in the stocks that make up the S&P 500 index. The index will usually decline when complacency is on the rise, as traders believe this broad based index will remain subdued.
The general idea is that the VIX goes up while the S&P 500 is falling. Looking at VIX charts that cover the period of the global financial crisis will confirm this. An investor can use the negative correlation to potentially predict movements in the S&P 500 index, or the market generally. As fear rises, and the VIX climbs, there is a higher chance that the S&P 500 will make a downward movement. The VIX can also be used as a contrarian indicator. When the VIX is low for a while, and complacency sets in, traders are not prepared for a shock, and therefore could experience a wild ride.
So if you’re into option trading strategies that involve the major indexes, or ETF’s such as the SPY, the DIA or the QQQs that are derived therefrom, using the VIX index becomes a very valuable enhancement to your strategy. For example, if your using Calendar Spreads or Iron Condors, which rely on the market to be reasonably complacent, checking the VIX before you time your entry might be something you won’t regret.
Using the VIX index in conjunction with safe option trading for consistent monthy income, is one of the hallmarks of the popular Trading Pro System series of videos.