The Ultimate Guide To The VIX Index

VIX Index

When stock markets plunge hard and fast, financial media headlines often report on the “spike” in the VIX. The CBOE Volatility index (VIX) is a market index on the Chicago Board of Exchange (CBOE) that measures the implied volatility of the S&P 500 index (SPX) options. It’s calculated as the expected change in the S&P 500 index for the next 30-day period based on call and put options and the risk-free interest rate of U.S. treasury bills.  The VIX has become synonymous with falling stock markets. It usually moves inversely with the S&P 500 index, but not all the time. 

What Is The VIX Index?

The VIX is a measurement of the forward expected volatility of the S&P 500 index. Originally introduced as the Sigma Index by authors Benner and Galai in 1987 to be a volatility index.


In 1993, Vanderbilt University Robert Whaley, in collaboration with the Chicago Board of Exchange (CBOE), helped develop and launch the real-time reporting of the VIX. The VIX itself (being an index) was not directly tradeable. This changed in 2004 when the CBOE launched the VIX futures for trading. In 2006, CBOE rolled out options trading in the VIX. Afterward, various levered exchange traded funds (ETFs) and exchange traded notes (ETNs) were developed for traders to directly trade VIX correlated (positive and negative) instruments.   

What Does The VIX Measure?

Often referred to as the fear gauge or fear index, the VIX technically represents volatility, not direction. The VIX usually carries an inverse relationship or negative correlation with the SPX. When the SPX rises, the VIX tends to fall and vice versa. However, the VIX can also have a positive correlation with the SPX (IE: SPX falls, and VIX falls). This can happen when the SPX slowly declines after a period of huge volatility. As volatility calms down, the VIX loses value despite the SPX continue to fall lower. Therefore, it’s very important not to assume that negative correlation always exists. 

S&P 500 vs. VIX

Volatility measures the magnitude of price fluctuations for a specified period of time. The VIX attempts to gauge the volatility expected for the next 30-days for the S&P 500. This forward expectation is referred to as implied volatility (IV). To best gauge forward expectations, the VIX is formulated using the market prices of the SPX options with front month contracts with more than 23 days until expiration and next-month contracts with less than 37 days until expiration.

How To Trade The VIX

While the VIX index can’t be directly traded (just as you can’t trade the Dow Jones Industrial Average (DJIA)), there are ETFs that track and mirror the VIX, which can be traded. Many of these ETFs and ETNs carry additional risk through embedded leverage and an eroding cost structure.


It’s crucial that traders don’t assume the VIX always correlates directly with the SPX. It’s a volatility measure first and foremost; therefore, VIX can spike up when the SPX goes from low volatility to high volatility spikes to the upside. This misunderstanding has caused many traders to blow out their accounts, assuming the VIX is a directional tool and must revert back to negative correlation with the direction of the SPX. While negative correlation usually exists with the SPX, traders must have the agility to spot when that correlation fades. This is especially crucial if using it as a hedging tool to offset long positions.

How To Trade The VIX With ETFs

The most widely traded VIX ETF is the ProShares Trust Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY). This ETF carries 2X leverage that tracks the one-day performance of the VIX futures. With that in mind, it’s crucial to understand this levered ETF is structured only to track the one-day performance of the VIX. This ETF’s counterpart, (NYSEARCA: SVXY) inversely tracks the performance of the VIX (allowing traders to “short” the VIX by taking a long position in SVXY).

Leveraged ETFs (especially short/inverse ETF’s) are not to be held long-term since they suffer from erosion, inversion, and contango. Any or all three of these factors can severely disrupt ETF pricing and throw traders into a conundrum. 

Contango And Time Decay

A common misunderstanding of the UVXY leads to a rude awakening when investors would experience the UVXY falling even when the SPX sold off over time. This is due to price gaps that erode the valuation since tracking is reset every morning. Underlying VIX futures can experience contango even when the VIX is flat.

Contango occurs when futures trade at a premium to the spot price ahead of expiration. Exchange traded products can’t be rolled over like futures; instead they undergo rebalancing that causes symptomatically triggers purchases at higher prices while selling at decayed lower prices. This, along with slippage from gaps, can result in monthly erosion ranging from eight to 13-percent on average per month. This means holding these ETFs for more than a few days to weeks is a losing proposition. Limiting exposure to intraday properly aligns with the purpose of the VIX Exchange Traded Products.

The information contained herein is intended as informational only and should not be considered as a recommendation of any sort. Every trader has a different risk tolerance and you should consider your own tolerance and financial situation before engaging in day trading. Day trading can result in a total loss of capital. Short selling and margin trading can significantly increase your risk and even result in debt owed to your broker. Please review our day trading risk disclosuremargin disclosure, and trading fees for more information on the risks and fees associated with trading.

Related Content

Head and Shoulders Chart Patterns

Head and Shoulders Chart Patterns

A head and shoulders chart pattern typically indicates a reversal at the end of an uptrend. It includes three peaks with troughs between them and can be followed by a significant breakdown. In this guide, we’ll highlight what traders need to know about head and...

How Do Market Makers Make Money?

How Do Market Makers Make Money?

If you've ever traded stocks, you've probably used a market maker. Market makers are the middlemen of the stock market, and in most cases, these are firms, individuals, and or large corporations that facilitate transactions. For example, if you wanted to buy shares...

How Long Can You Hold a Short Position?

How Long Can You Hold a Short Position?

Investors can hold onto long positions for years or even decades without running into problems. But most short positions are much shorter in duration – a few months to a few years at most. There are several practical limitations that limit how much time traders can...

How to Interpret Level 2 Data

How to Interpret Level 2 Data

Level 2 data is important for traders because it shows the full range of open orders for a stock, not just the current best bid and ask price. Using Level 2 data, you can identify potential trades before they become apparent on technical charts or get additional...

Doji Candlestick Patterns

Doji Candlestick Patterns

A Doji is a type of candlestick pattern that often indicates a coming price reversal. This pattern consists of a single candlestick with a nearly identical open and close. In this guide, we’ll explain what the doji candlestick is and how traders can interpret it. How...

How Does Inflation Affect the Stock Market?

How Does Inflation Affect the Stock Market?

Inflation can have a big impact on the stock market, leaving unprepared investors in for a bumpy ride. In this article, we’ll explain why inflation impacts the stock market and take a closer look at how the stock market has reacted to inflation in the past. What is...