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The $VIX is the 30-day annualized implied volatility of the S&P 500 Index Options.
In addition, the $VXN is the 30-day annualized implied volatility of the Nasdaq 100 Index Options.
When markets crash or move downward quickly, put options (see: Put Options) often become quite popular. Traders bid up the price of these put options, which manifests itself as an increase in the implied volatility level; thus an increase in the $VIX and $VXN index.
The basic relationship between stock and index prices and the $VIX and $VXN is presented next:
- When prices fall, the $VIX and $VXN Indexes rise.
- In contrast, when prices rise, the $VIX and $VXN Indexes fall.
This basic relationship is summed up by a famous traders' saying: “When the VIX is high it's time to buy; when the VIX is low it's time to go.”
The following chart of the S&P 500 exchange traded fund (SPY), top half of chart, shows the inverse relationship between it and the $VIX Volatility Index, bottom half of chart:
Notice how, in this example, an uptrend in the price of the S&P 500 is accompanied by a downtrend in the level of the $VIX.
The next chart of the Nasdaq 100 exchange traded fund (QQQQ) shows potential buying opportunities when the $VXN spikes higher:
VIX & VXN Potential Buy Signal
When the $VIX or $VXN spike (usually they both spike during the same periods) a trader might go contrarian and buy.
If history repeats itself, buying $VIX and $VXN spikes may prove profitable. Nevertheless, the Mutual Fund mantra applies: “Past performance is not indicative of future performance“.
The trend of the $VIX and $VXN Indexes can add another helpful level of analysis to price and volume indicators.
A technical indicator that might be of interest is the Volatility indicator (see: Volatility).
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