What is the VIX?
VIX is a derived from the implied volatility of the at the money options on the S&P 500 index.
In the simplest sense, there are various factors used in black scholes option pricing from the value of the underlying, strike price of the option, interest rate, dividends and volatility. VIX can be estimate by holding all other assumptions constant to find the volatility variable.
We always keep an eye on the index. Whilst we are more cautious during periods of low VIX as it tends to spike sharply correlating with equity market falls.
A low VIX does not mean that market is going to crash but it is a sign of complacency. On the opposite end of the spectrum, we love periods of high VIX because this means that market is in a period of dislocation where we put our list of stocks to buy to work and easier to find value in the market.
Define volatility
Volatility in the financial context is defined as deviation from the mean. Volatility has a tendency to cluster which means that periods of low volatility tends to occur together. When there is a shock to the system due to unforeseen events like a coup in Turkey or Brexit. Volatility shoots up sharply.
Then it is commonly followed by a prolong period of high volatility.
Chart of VIX below highlights patterns of clustering. The index tend to rise sharply after spending time at the lower end of the range then gradually tapers off.
