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VIX

There are many indicators that trader's follow to try to predict market bottoms and market tops. There is never just one indicator that tells the whole story, but one that you might want to add to your arsenal, if it is not already there, is the Market Volatility Index (VIX). This index was established by the CBOE in 1993. The VIX is a measure of stock market volatility and uncertainty.

Although the VIX is only a general measure of volatility in the OEX, trader's use this as a general indication of index option implied volatility and as an indicator of volatility of the U.S. equity market.

When the VIX is at a low value in the teens, it indicates complacency in the market - there is not much fear. This tends to be a bearish indication for the market. The VIX hovered around 20 in January 2000 when the DOW peaked.

The VIX goes up when there is a lot of fear in the market because option traders are willing to pay a higher premium when they purchase options. Higher option premiums result in higher implied volatilities (driving the VIX higher).

The VIX can be used to help determine market bottoms. During October 1998, when there was a lot of fear in the market, the VIX reached a high value of 60 and the market bottomed. Market bottoms generally occur when fear reaches its highest point. So when the VIX reaches its peak, it is a bullish indicator.

The VIX is a sentiment indicator and works in a contrarian way. When the market is most fearful, as it is going down, the VIX gives a bullish signal that the market is prone to a reversal, sending the market up. When the market is most complacent, as it is going up, the VIX gives a bearish signal that the market is prone to a reversal, sending the market down.

The CBOE changed the method it uses to calculate the VIX in September 2003, broadening the number of options included in the computation and basing it on the S&P 500 option series rather than the S&P 100 series. Thus key reversal levels should be revalidated over time since prior history is not as relevant as it was.

When the VIX gets high, options are getting more expensive. At times like that, it is very important to calculate fair value for the option you are considering, so that you know how much over fair value you are paying for the option and determine how much risk you are you are really taking on. Then it is especially important to have a good options analysis program like Option-Aid. Buy Option-Aid today and increase your trading profits. It can determine fair value for the options you are looking at and calculate the probability of you making a profit or taking a loss. If you pay too much for an option, the underlying asset could move in the direction you predicted, yet you might find your profits disappear as volatilities moderate and option premiums return to more normal values.

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