Does the VIX volatility indicator still matter?

The VIX has been synonymous with market sentiment

Rob Isbitts

VIX index

The CBOE Market Volatility index (VIX) has been relied on by traders and investors since its debut in 1993.

VIX futures contracts were added in 2004. Since that time, the VIX has been synonymous with market sentiment.

When it lays low, it typically indicates a calm market that is either rising or at least not skittish and falling and when VIX spikes above 20, then 30 or even north of 60 on occasion, that has synched up with market dips, dives and crashes over the past few decades.

But markets do not work like they used to. New players such as algorithmic traders, high-frequency trading and even the emergence of the retail investor, both as meme stock devotees and others, have changed the game.

And of course, there is indexing and the explosion of popularity of ETFs, growing the trillions each year. So, is the VIX still useful in this modern market environment?

There is a good argument that the VIX is currently reflecting the confident mood of the market, having remained under the 15 level for nearly all of the past five months’ stock market run-up.

Just before that remarkable rally, VIX briefly popped above 20, and peaked at 30 just one year ago, when stocks were still trying to shake off 2022’s horrendous year.

The VIX appears to be doing what it always does. That means advisers can use it as a portfolio hedge, to exploit a continued calm market or even as a substitute for using options, which are not easy to arrange for all clients.

In the US, investors can access VIX-linked ETFs in three ways. One is via the $788m Simplify Volatility Premium ETF (SVOL), an actively managed strategy that utilises options to protect against adverse moves in the VIX.

The other options are taking more direct exposure via the $157m ProShares VIX Short-Term Futures ETF (VIXY) and the $306m ProShares Short VIX Short-Term Futures ETF (SVXY) which long and short the VIX, respectively.

Bottom line

These ETFs are designed for short-term holding periods. But as alluded to earlier, their return profiles could be thought of as surrogates for put options (VIXY) and call options (SVXY) on the S&P 500, where a very small position can potentially pay off in either direction.

The mistake would be allocating to these the way one would allocate to stocks or bonds. Their volatility is too high for taking large portfolio positions.

Today’s stock market is full of surprises, alongside opportunities. With at least these three different approaches to use the VIX as the anchor of risk management strategies, it appears the demise of the 30-year-old market volatility indicator has been greatly exaggerated.

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