Coronavirus has thoroughly walloped global markets, wiping billions from the ASX and trillions from Wall Street.
But according to CMC Markets head of Asia-Pacific sales Ben Charbonneau, this index, dubbed the VIX or ‘fear index’ doesn’t just warn of future volatility, it can also be used to protect against it.
What’s the fear index?
The fear index is a real-time market index that measures the purchase of options. Options are contracts which investors can buy that allow them to buy or sell shares at a predetermined price.
Investors commonly purchase them as protection against volatility, and as more people purchase options, they drive up the price.
The fear index measures the price of S&P500 options, and in turn, delivers an indicator of investor sentiment and market risk in the form of a number.
“A lot of people, they look at the VIX and they say, ‘Well what does that number mean?’ and they say, ‘Well if the number is low it’s going well,’” Charbonneau said.
“[But] that number is actually a percentage, so right now the VIX is roughly 35, so that’s 35 per cent.”
That means that over the next 30 days, investors are expecting the price to fluctuate 35 per cent.
“We don’t know if it’s going to go up, or down, but the amount of volatility is expected to be around 35 per cent.”
Generally, the index will fluctuate between 12 and 16 but in March it was around 83 as investor concerns reached boiling point.
How do investors use the fear index?
While the index indicates fear in the market, iIf you want to use it as an investor, you need to approach it as an alert, Charbonneau said.
He said investors and traders may choose to use it with predetermined rules. For example, they may choose to monitor the VIX, and once it hits a number like 30 or 40, they take that as an alert that maybe now would be a good time to seek out protection.
“A lot of people will use the VIX as a trigger for their trading strategy,” he said.
“If you’re an active trader, that’s when you say, ‘Well it just spiked 25, now I’m going to activate this trading strategy that allows me to short the S&P500 based on this.’”
But for retail investors, a better option might be to seek out ETFs which chart the price of the VIX.
“So, if I had a portfolio that I wanted to protect, as an individual investor, rather than having to deal with shorts or anything like that, I can basically buy an ETF that tracks the VIX,” he said.
“As that ETF rises in value, that basically offsets the losses in the underlying portfolio.”
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