The VIX (18.90, up 0.72) or Volatility Index is a tool you can use to gauge market volatility. It is modeled after the S&P 500 and gives you an idea of investors’ confidence or non-confidence in the market. The key point here is that the value of the VIX increases as the market goes down and decreases when the market moves up. So if the market trades lower, usually the VIX is up. If the market is up, the VIX trades lower.

I mentioned last week that the market was testing its highs from January with the S&P 500 closing above 1,400. After three losing months to start the year, was April a harbinger? If so, it’s no coincidence that the VIX is below 20.

If the VIX is below 20 then it means the market is confident. The VIX was at 35 on March 17 and the S&P 500 stood at 1,276. If the VIX is at 30 or more then it means the market is nervous. See the correlation? Now that the S&P 500 is challenging its highs, the VIX is below 20.

So how low can the VIX go? Well the 52-week low is 12.43, and the 52-week high is 37.57. If the market can break through key resistance then the VIX is headed lower. No one can predict exactly what will happen in the market (although some claim to) but by using the VIX you can prepare for what COULD happen.

And yes you can trade options on the VIX. Options on the VIX didn’t start trading until 2006 but they have gained popularity in their short existence. Just to give you an example, I’ll use some June quotes since the May options are expiring soon.

June 18 put (VIXRS, $0.50, down $0.05)
June 18 call (VIXFS, $3.49, up $0.26)

As you can see with the S&P 500 trading lower yesterday, the calls traded HIGHER because the market was DOWN. It may take a while to get the concept down for those of you that have just been introduced to the VIX but just remember it’s opposite. Usually a call option will go up in value if the stock trades higher and puts will trade higher if the stock trades lower. With the VIX, if the market is down the calls are up. If the market is up, the puts are up.

Let’s watch the VIX over the next few weeks or months and see where it goes. You may have to wait until we get some more market extremes before thinking of using VIX puts but if the market fails at current resistance, there could be some buying going on.

Rick Rouse