How to Trade VIX – Wall Street’s Fear Index

short vix strategy

Learn how to trade VIX with our in-house developed VIX trading strategy. Often quoted as Wall Street’s fear gauge, VIX trading is a popular way to measure the level of risk in the stock market. But, how does trading the VIX work, how to use the VIX in trading, the best way to trade VIX and more will be revealed throughout this practical guide on how to use VIX in trading?

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The Chicago Board Options Exchange (CBOE) volatility index is mostly grounded on protection against negative market movements. That’s why when the stock market crashes, the most important index used on Wall Street is the fear gauge VIX.

The VIX volatility index is monitored carefully by hedge fund managers and professional traders for signs of trouble. If all the big players are watching the VIX you might wonder how to trade VIX strategies?

We’ve got your back covered.

But, let’s start things off by defining what is VIX in trading and how to trade VIX.

Are you ready?

Then, let’s begin…

vix trading strategy

In simple terms, the VIX is the volatility index and it measures the fear of investors in the market in the US benchmark equity index S&P 500. VIX index usually shows the expected 30-day volatility of the S&P 500. On Wall Street, it’s also referred to as the Fear Index or the Uncertainty Index. The IVX was first introduced in 1993 as the ticker symbol for the CBOE volatility index.

See the VIX index chart below:

day trading using vix

So, how to trade VIX index?

The VIX increases on higher volatility and drops on lower volatility.

VIX in trading can give investors an insight into the “feelings” of the market or the market sentiment.

When you think about how do you trade VIX options, you need to ask yourself the following types of questions:

  • Are traders feeling scared?
  • Are traders feeling anxious?
  • Or, investors are confident?

If you know the answers to these questions, you will know how to trade VIX.

Let’s talk about VIX index trading and answer the question: can you trade VIX directly?

See below:

how to trade vix

In this section, we’re going to look at different ways on how to trade VIX directly.

Many people have asked:

“Can I trade the VIX directly?”

The short answer is NO

As you might think, the VIX is an index rather than an asset, so this means it can’t be traded directly. However, if investors want to trade based on the VIX, they need to use derivatives or other financial instruments that are linked to the volatility index.

Trading VIX derivatives can be done using a variety of options, futures and other ETFs and ETNs that relate to the VIX, which includes the VXX, UVXY, VIXY, VIIX or TVIX.

The most straightforward approach is to buy an Exchange Traded Note (ETN). The most popular ETN on VIX is the VelocityShares Daily Inverse VIX (XIV). As you can tell, it’s inverse to the VIX, which means that when the VIX drops, then XIV is going up. Conversely, when VIX goes up, then XIV is going down.

ETNs are very complex derivatives and are designed to be like a ticking time bomb.

That’s why we’re only going to focus on trading the VIX options.

Options trading is really all about trading volatility.

That’s the reason why the best way to trade VIX is through options.

The VIX oscillates with the ebb and flow. It drifts and then spikes and the process is repeated. So, trying to apply technical analysis is futile. Once you understand that the VIX is simply the implied volatility of S&P 500 options.

Then you might be wondering…

How can I trade the VIX?

See below:

How to put the odds in our favor when trading VIX, that’s what we’re going to discuss in this section.

There is an old industry mantra that says:

  1. When VIX is high it’s time to buy the S&P 500
  2. When VIX is low it’s time to get out of the market

vix trading strategy

However, when we put into practice this VIX trading strategy; we can notice that when the VIX is low the market is often moving in a slow and steady bullish trend. So, if you were to follow this VIX trading strategy, you would have missed some of the biggest bullish trends out there.

So, that’s clearly how to trade VIX stock the wrong way.

Note* While this VIX trading strategy works when the VIX reading is high, it can’t be said the same when the VIX is low.

You can buy calls on the VIX when you see that volatility is starting to creep up in the market. This is a classic long VIX strategy. Now, this is not really the best way to trade VIX, as there are other ways to trade the VIX.

So, how can you trade the VIX differently?

For example, you can also do a debit spread on the VIX. This VIX trading strategy can be successfully implemented when you expect some kind of volatility in the market. Or, when there is a news announcement the VIX futures strategy can help you cap the risk.

Learn more how to use the options spread strategies to limit the risks and the fear of losing money: Options Spread Strategies – How to Win in Any Market.

However, on the downside, these types of VIX strategies can limit the maximum return as well.

On the cautious side, trading VIX options needs to be done properly because volatility can be pretty sporadic. Or, there might not be any volatility at all.

best way to trade vix

Pinpointing the exact moves when the volatility will increase is hard because the VIX doesn’t really respond to technical analysis. The VIX trading system responds better to fundamentals because it’s a measure of implied volatility on an index.

Note * in the summer market the VIX option trading strategies are a little harder to trade.

Moving forward, let’s examine the best way to trade the VIX.

See below:

how to trade vix

The best way to trade VIX is to use it as a hedging tool. Trading VIX works best when you think the market is going down.

So, how do I trade the VIX to hedge my risk?

If you want to keep the risk under control and protect your positions you can step into the world of VIX options trading strategies. Learn How to Trade Stock Options for Beginners – Best Options Trading Strategy.

Now, you’re probably wondering…

How to trade the VIX options?

Investors typically buy VIX calls as a portfolio hedge against a rise in volatility. This is also referred to as going long volatility. Here is an explanation of how to use VIX in trading with options.

The more investors that start to use the VIX options, because the market is believed to go down, the more these VIX options will expand. In other words, investors will need to pay more from the options point of view in order to protect against the risk.

Therefore, when a lot of people are getting nervous the VIX will start to get higher and higher. This is just basic supply and demand.

Consequently, when investors aren’t rushing into VIX options, the volatility will be very mildly. This is how to trade VIX options with the best approach.

Another approach on how to trade VIX is following a 3 simple step process:

  • Identify the trend (it’s up or it’s down)
  • If we have an uptrend we look for pullbacks into demand (we use the demand zone as potential buy zones)
  • We use the VIX to confirm the buy signal.

See the VIX chart below:

how to trade vix

Since we have identified a bullish trend, we want to ride the trend at the ideal spot. We’re going to use the VIX high levels to confirm if it’s a good time to buy or not. Remember, when VIX is high, it’s time to buy. So, if the VIX trading signals are confirmed in an area of demand we have a higher chance of being on the right side of the market.

Next, we’re going to talk about how to trade VIX strategies.

See below:

So, how do you trade the VIX index?

One of the most common VIX trading strategy used for portfolio hedging is using VIX calls. Instead of buying S&P 500 puts a more effective way to prepare for a market downturn is to use VIX calls.

More precisely, we’re going to use the reverse collar VIX trading strategy.

Now, reverse collar options trading involve 3 positions as follows:

  • Being long the S&P 500
  • Short VIX Call position
  • Long VIX Put position

Let’s dive into the basic characteristics of how to trade VIX with the reverse collar strategy.

To implement the reverse collar hedging strategy, investors need to simultaneously:

  • Buy out-of-the-money VIX calls
  • Sell out-of-the-money VIX puts with the same expiration date

Ideally, the sale of the VIX puts should cover the VIX calls, hedging the portfolio without paying any premium.

The idea behind this hedging VIX trading strategy is that in case of a stock market crash or a correction, the VIX will spike enough so that the purchased VIX calls will gain enough to offset the losses from the long S&P 500 position.

Now, you may ask yourself…

How to put this VIX hedging strategy into practice?

Let’s consider a hypothetical example, where the S&P 500 is trading near all-time highs at 3300. However, you think a correction is imminent and you want to protect your longs against the downside risks. At the same time, the VIX is trading at 15.2.

Additionally, the options prices are the following:

  • August VIX calls, with a strike price of $17, are priced at $0.35 each
  • August VIX puts, with a strike price of $10.50, are priced at $0.25 each

This reverse collar strategy will give you a credit of $0.10. In this situation, our maximum loss is equal to the put price minus the credit ($10.50 – $0.10). This happens if the S&P 500 is below the put price and equal to the debit if S&P 500 ends between the strikes at the expiration date.

In summary, the fear index VIX can tell you a lot about the market and allows you to determine the market sentiment. In times of fear, VIX trading options is the most efficient strategy to hedge your portfolio against downside risk. The VIX trading strategy presented through this guide is only a small example of the things that can be accomplished with the VIX.

Please note that the best way to trade VIX comes down to your current position and market conditions. One VIX trading approach might work only when the market conditions suit that strategy while when the market conditions change you can get different results.

Develop the habit to monitor the VIX daily and make it part of your trading routine

Thank you for reading!

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