Fear Index
How to understand market volatility risk on your portfolio ?
As made famous by the legendary HBO-series - Industry
I do love Bitcoin - this was just too good of an opportunity to not quote Industry
VIX is the heart monitor for the stock market, or as we call it south of 14th in Manhattan … its the Wall Street Fear Gauge
That sounds ominous though - but fine, I’ll let that be
Essentially, VIX checks the respiratory health of investors day in and day out and plots a signal
Before I get into the mechanics of what it actually is - say, if you only had 30 seconds, and need to understand what the hell happened with the stock market for the last year or so, you’d just look at VIX
Here you go - just look at it, and it’ll tell you what happened
Let me try, the baby-spike in April last year is because of the Israel-Iran conflict, and the big-momma spike in August is when the Japanese Yen Carry trade blew up the market
Isn’t it just beautiful ? You can explain the entire world in one plot
The one below is the VIX for just this week
DJT imposed tariffs on Mexico, Canada and China earlier this week on Monday and Tuesday. He then gave a 30 day reprieve for automakers … and third and finally (?) - he exempted more items from Canada and Mexico
DJT doin’ DJT things - Yes
But, the constant whipsaw on trade policy is what wrecks the market and sends it into a full-blown panic
This is the VIX for the last 30 days, it has slowly been picking up steam and it came to a head this week
VIX is the Chicago Board Options Exchange CBOE Volatility Index, essentially - it is the stock market investor expectations of volatility, based on S&P 500 index options
In simple speak : it tells you, what investors think the volatility of the stock market would be in the near future (~ 30 days), based on how they buy and sell options
So, in the plot above, VIX at the end of the day this week is ~ 23.37. It means, the market expects the volatility of the stock market to be 23.37% over the next 12 months. So, it is 23.37/SQRT(12) = 6.7%, over the next month
So, if your S&P 500 portfolio is about 100,000 right now, then in the next month, it can potentially range between $ 93,300 and $ 106,700
If you don’t like that swing then you need to hedge, and hedge fast. That’s how you would use VIX to understand the volatility in your own portfolio
You can easily access VIX from here, or here
Now, to what is inside the box
You only need to know two things to understand VIX - we call them PUTS and CALLS in options trading (we have talked about options before). Just think of them as insurance for your stock
Say, AAPL is trading at $ 250 today, and in 30 days, it drops to $ 200
Buying a Put gives you the right to sell a stock, in 30 days, at a specific price. If you pay a premium and buy a put today for a strike price of $ 220 (strike price is the price at which you want to sell it) …
You can still sell AAPL at $ 220 in 30 days or less, even if the market price of AAPL is $ 200
So, why would you do this as an investor ? You’d do this because, you expect swings or volatility - which is VIX, and you want to be able to sell AAPL at $ 220, even if it drops to $ 200
You pay for that insurance, but you’ll sleep better
Yeah ?
Lets do Calls
Say, AAPL is trading at $ 250 today, and in 30 days, it spikes to $ 275
Buying a Call gives the holder the right to buy a stock, at the price for which you bought the call for
Say, if you bought a call at $ 260, you can buy the stock at $ 260 in 30 days or less, even if the market price is $ 275
You buy it at $ 260, and sell it at $ 275 in the open market - your gain from this trade is + $ 15
That’s about it
Buying Puts is an insurance against market panic and buying Calls is an insurance against you missing out on the upside
If you think about the intuition, it makes sense, right ?
Say, the entire S&P 500 index is trading at $ 1000 a stock today, investors will buy a lot of puts if they expect the market to drop, and they’ll buy a lot of calls if they expect the market to pop
Regardless of what it is that we buy, puts, calls, Kit-Kats or eggs … when we buy more of something, the price of it increases. When investors buy puts or calls, the price of those options increases
- by using information on how many puts and calls they buy, and at what prices they buy them - we estimate the implied volatility of the market
If something is trading at 250, why would a lot of people buy Puts at a price of 220 for the next 30 days or less, its because they expect a lot of volatility in stock price over the next month, and they expect the market to drop
That’s precisely the information we use to estimate implied volatility. I have very little patience for anyone’s opinion or forecast online, but I’m fine looking at investor sentiment for the entire S&P 500
The investors buying puts and calls can very well be wrong of course, but your next best option is to trust someone screaming on X, or a crypto bro, who thinks the United States Dollar is the bane of everyone’s existence
VIX essentially mathematically captures investor sentiment regarding the volatility of the stock market for the next 30 days
Here is all of VIX since the dawn of time
It’s simple, right ? 1998 was when Russia defaulted on its debt obligations and LTCM (in Connecticut) had significant exposure to that, 9/11 was … well 9/11, 2008 was the global financial crisis and 2020 was COVID
Every time when somethin’ goes wrong with the world, VIX throws a tantrum. In the long run, after we come back to our senses, VIX reverses to a mean of ~ 20
And since it always decreases in the long run
The term Short the Vix (betting on it to go down), ends up on a coffee mug
Yeah ?
Long term VIX is ~ 20, VIX right now is ~ 23.37, that’s a significant spike at about 17% higher than its long term average
DJT shoots from the hip all the time, hence you need to understand VIX - so that you aren’t flyin’ blind