Volatility Index VIX: A Quantitative Barometer of Market Risk and Investment Application Guide

Core Definition of the Volatility Index VIX

During periods of intense market turbulence, investors often need a quantitative tool to accurately measure market panic levels. This tool is the Volatility Index VIX. When the stock market is in trouble, the VIX panic index rapidly rises, soaring significantly.

The full name of the VIX panic index is the Volatility Index, created and maintained by the Chicago Board Options Exchange (CBOE) in 1993. This index measures market participants’ expectations of volatility for the next 30 trading days of the S&P 500 index.

The operation logic of this index is straightforward: the higher the VIX index value, the greater the expected market volatility and risk; the lower the VIX index value, the lower the expected volatility and the more stable the market. Since investors typically use VIX to quantify market risk, fear, or pressure levels, this volatility index is also known as the “fear index” and is regarded as a unique indicator of market sentiment in the financial industry.

Calculation Mechanism of the VIX Panic Index

The core of VIX calculation is based on implied volatility analysis of S&P 500 options prices. Specifically, the process includes:

First, collecting prices of S&P 500 call and put options with different expiration dates and strike prices, then calculating the implied volatility for each option based on these prices. Finally, using a weighted average method to integrate the data from various options, to derive the final VIX index value.

It is important to note that the VIX reflects expected volatility over the next 30 days, expressed as an annualized percentage, following a normal distribution probability. For example, if the VIX is 15, it indicates an expected annual volatility of 15%, meaning the standard deviation of expected volatility over the next 30 days is 4.33%, with a 68% probability that the S&P 500 index’s fluctuation range in the next 30 days will be within ±4.33%.

Levels of the VIX Panic Index

Based on historical data, the VIX panic index has a clear grading system:

• 0-15: Market is relatively stable and optimistic
• 15-20: Market is in a normal state
• 20-25: Market concerns are gradually rising
• 25-30: Market volatility intensifies
• Above 30: Market falls into panic mode

Overview of VIX-Related Investment Products

Since the Chicago Board Options Exchange launched VIX futures in 2004, followed by VIX options two years later, VIX derivatives began trading on exchanges. Currently, the main VIX-related products include:

VIX Futures Contracts allow investors to settle VIX at a specific price on a future date, enabling speculation based on market volatility expectations.

VIX Options Contracts are similar to stock options, allowing investors to buy or sell VIX futures at a specific price within a certain period, used for hedging or speculative trading.

VIX Exchange-Traded Funds (VIX ETFs) mostly track the VIX futures index. The US stock market offers a variety of VIX-related ETFs. For investors, the simplest way to participate in VIX index investment is to buy and sell highly liquid ETF or ETN products, such as VXX, VIXY, UVXY, which have relatively straightforward trading strategies similar to stocks.

Mainstream VIX ETF and ETN Product Comparison

The main VIX products on the market include options with different leverage multiples and expiration periods. Short-term bullish products like VIXY and UVXY are often chosen by investors as hedging tools during sharp declines. However, these products have inherent flaws—since futures have expiration dates, they require roll-over trading. When VIX remains low over the long term, continuous roll-over can lead to persistent value erosion of these products.

Core Characteristics of the VIX Panic Index

Real-time reflection of market sentiment: As a forecasting tool, VIX provides an estimate of market volatility over the next 30 days, rather than historical volatility, making it a widely used indicator of market sentiment and risk appetite.

Precise measurement of panic levels: During sharp stock market swings or declines, investors tend to seek protection, increasing options buying activity and pushing VIX higher. Higher VIX readings are usually strongly associated with market panic and risk aversion.

Potential application as a contrarian indicator: Since VIX often peaks at market lows and bottoms at market highs, some traders use it as a contrarian indicator. When VIX is abnormally high, it may signal a buying opportunity; when abnormally low, consider selling or adopting a cautious stance.

Mean reversion over the long term: Long-term observations show that VIX exhibits mean reversion. Regardless of market conditions, if VIX rises too high, it will eventually fall back; similarly, if it drops too low, it tends to rebound.

Historical Crisis Periods and VIX Performance

The VIX panic index is highly sensitive to market crises. Whenever major events occur, the index shows significant volatility.

During the Asian financial crisis in 1997, the September 11 attacks in 2001, the 2008 financial crisis, the European debt crisis in 2010, the US-China trade war in 2018-2019, and the COVID-19 pandemic in 2020, VIX values surged sharply. Notably, during the 2008 crisis, VIX approached 80, indicating extreme panic.

Research shows that VIX also tends to follow an interesting pattern—it often rises before US presidential elections. On average, compared to the readings 60 days before the November election, VIX tends to be higher on election day. This phenomenon is explained by investors hedging against potential political uncertainty.

For example, during the 2008 US presidential election, VIX nearly doubled in the two months prior to the election. After the results were announced, VIX continued to rise as the Democratic candidate defeated the incumbent Republican administration. In the 2020 US election, VIX showed a typical pattern of rising first and then falling, reaching a peak of 41.16 on October 29, then dropping sharply after the election day.

Application of the Volatility Index in the Taiwan Market

Taiwan’s stock market also has its own volatility indicator—TAIWAN VIX, developed by the Taiwan Futures Exchange in 2006 based on Taiwan index options.

As a typical outward-looking economy with high levels of liberalization and globalization, Taiwan’s stock performance is heavily influenced by external factors such as international politics, economics, and finance, especially showing a strong positive correlation with the US economy. Therefore, large fluctuations in Taiwan stocks and the Taiwan VIX are often closely related to external factors.

In recent years, the Taiwan VIX has broken above 30 three times. The highest occurred during the global COVID-19 pandemic—on March 23, 2020, when the Taiwan stock index plunged 344 points to 8,900, and the Taiwan VIX hit 57. At that time, the COVID-19 pandemic was spreading worldwide, causing global financial markets to be turbulent.

In May 2021, Taiwan’s pandemic escalation caused the stock index to plunge again, with the Taiwan VIX approaching 40. The previous time Taiwan VIX broke above 30 was on February 6, 2018, when US stocks plummeted, triggering panic; Taiwan stocks fell by 645 points, and the Taiwan VIX surged above 30. Since 2023, Taiwan stocks have begun to rebound steadily, with the Taiwan VIX mostly fluctuating between 10 and 20.

Dynamic Relationship Between VIX and US Stock Indices

The VIX panic index is closely related to the S&P 500 index. Generally, when the S&P 500 declines or market volatility increases, the VIX tends to rise correspondingly, and vice versa. However, this inverse relationship is not absolute; market trends and investor sentiment are influenced by various factors, including economic data, policy changes, and geopolitical events.

Regarding the relationship between VIX and indices like Nasdaq or Dow Jones, there is some mutual influence but not a direct causal link. First, the volatility levels of these indices affect the VIX level. Large fluctuations usually indicate tense market sentiment, potentially raising VIX. Second, changes in VIX can also influence investor psychology and trading behavior, indirectly affecting other indices.

Using the Fear Index for Investment Decisions

Early Warning of Specific Events

The VIX index is highly sensitive to the impact of specific events. When major events occur or market uncertainty rises, VIX often exhibits sharp fluctuations. Investors can observe VIX changes to gauge market reactions and sentiment regarding these events. Economic data releases, political events, financial crises, etc., can trigger significant VIX movements, serving as alerts for market risk.

Guidance for Investment Strategies

VIX can guide investors on investment directions. Typically, when VIX levels are low, indicating market stability, investors might consider buying or entering the market on dips. When VIX levels are high, signaling market instability, investors may adopt conservative strategies, reduce positions, or hold hedging assets.

Reference for Hedging Tool Selection

VIX also serves as a reference for choosing hedging tools. When market volatility is expected to increase, volatility derivatives and other hedging instruments can provide protection. Investors can decide whether to use these tools based on the VIX level and its changes.

It is important to emphasize that a high VIX does not necessarily mean a bear market is coming. VIX measures market expectations of S&P 500 volatility and cannot perfectly predict market direction. Although rising volatility often reflects market uncertainty, once uncertainty is resolved, even if the market continues to decline slightly, going long on VIX may not perfectly hedge the market decline. This explains why sometimes the market falls without a corresponding rise in VIX.

Summary and Investment Advice

For stock investors, the VIX panic index is an essential indicator to understand. However, VIX is not an absolute predictor of future market movements; it merely reflects market sentiment and volatility. Investors can incorporate VIX-related financial products into their trading strategies based on their expectations of future market volatility.

Nevertheless, VIX also has limitations. In actual trading, investors should consider multiple factors, conduct comprehensive market analysis, and implement risk management to develop appropriate investment strategies.