Using VIX as a Market Indicator

11/02/2011 1:30 am EST

Focus: OPTIONS

James Bittman

Senior Instructor, Chicago Board Options Exchange

CBOE options instructor Jim Bittman explains that the Volatility Index (VIX) can act as a critical market barometer and shares past examples where VIX action foretold major stock market bottoms.

Jim Bittman is my guest, and Jim is the senior instructor at the Options Institute. Tell me everything that I need to know about the VIX, the volatility index.

Well, it has been a very popular product in the recent years; it measures the implied volatility of options on the S&P 500 Index, the so-called SPX options. It is kind of a contrary market indicator; when VIX goes up, that tends to coincide with the market going down, and vice versa.

People use it in a variety of ways. You can buy options on the VIX to speculate on volatility direction; you can use it as a way of hedging your portfolio; or you can use it as a market indicator.

It is a very interesting technique, but when the market is going down (with new lows) but the VIX index stops hitting new highs, then that is kind of an early indicator, in some cases, that the decline is over.

If you look back at March of 2009, you will see that the market was hitting new lows, but the VIX index was not hitting new highs. That was in retrospect an ideal indicator that the market decline was over.

There have been similar cases in 2010 and in 2011 on a much shorter-term basis.

How do I interpret it now; what is it telling me?

Well in the spring and early summer of 2011, the VIX was rising; that was definitely a warning sign to a negative sign. As the market continued to hit at least short-term lower lows, as long VIX was rising, that was saying that we were in for more bearish moves.

So it kind of confirmed the “Sell in May and Go Away” strategy that many talked about?

Right now, that certainly seems to be the case.

What is the signal again that I should watch for in the VIX?

Well if VIX hits new highs, then the belief is that the market has not yet hit a bottom. When the market does go to a lower low and VIX does not go to a higher high, then that is the first indication that the bottom is either near or right at hand.

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