This week VIX, also known as the “investor fear gauge”, fell to its lowest level since Dec. 27, 1993. While some investors look to VIX as an indicator of market volatility or as a contrarian indicator of market direction I thought it might be useful to simplify what VIX is and how it can be used.
  
VIX is the ticker for the Chicago Board of Options Exchange Volatility Index. It is a computed index that is calculated using the price of options on the S&P 500. It measures investor expectations for market turbulence going out 30-days and is used as a hedging tool for bullish investors.
  
To hedge a portfolio against market moving events, investors that are long stocks can go long the VIX, through an ETF or buying options on the VIX itself. If a correction in the market occurs, the VIX can spike higher resulting in gains that will offset losses in a portfolio.
  
Another use is to interpret VIX as a contrarian indicator. When VIX falls to extreme levels, such as what we currently have, it can signal that investors are too complacent. That can imply that everyone is already long the market and new buyers aren’t to be found. In that case, a “bump” in the stock market could quickly lead investors to over react and the market could over compensate to the downside.
  
While it’s a useful tool don’t use the VIX as an indicator of the market’s future direction. A low VIX doesn’t signal a market reversal is imminent. Piper Jaffrey technical analyst Craig Johnson recently noted on CNBC that when looking at historical data on the VIX, the last nine times the VIX fell below 12, the market had rallied about 75% of the time with an average return of about 4.5%. He says, “I look at this and say, it’s low, but this is a positive sign, and the VIX is not a good gauge for picking tops. It’s a better gauge for picking bottoms.”
  
One last note, since the VIX was created, the emergence of leveraged ETFs give investors other ways to hedge portfolios and different investments. If you want to know more about how you can buy ‘insurance’ for your portfolio and whether it’s appropriate for your investments I’d recommend discussing it with a qualified financial advisor.

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