The VIX: Using the Uncertainty Index for Profit and Hedging 5.00 / 5 (100.00%) 1 vote

When it comes to equity and option investments, volatility is a major factor. The Chicago Board Options Exchange Market Volatility Index (a.k.a. VIX) watches this index to see what attitudes exist in regards to the market and short-term trading. This is why the VIX: using the uncertainty index for profit and hedging is so important to understand.

What VIX Is and Isnt

The VIX is a weighted index. It combines several S&P 500 index options with the belief that the more premiums, the more uncertainty in regards to the markets direction. As such, its meant to be a forward-looking representation of the markets short-term volatility.

Although its frequently used to measure complacency, this isnt what its meant to do. Instead, its meant to show risk. Its not a direct measure of this though because nobody agrees upon whats meant by risk. Most investors do say that this is a portfolios historical volatility movement.

How to Profit from VIX

There are a variety of ways in which to incorporate VIX into your portfolio. Exchange traded notes (ETNs) are the most popular though. They allow you to buy and sell instruments that are designed to be similar to some target indices and hold a collection of rolling fixtures. You will also find that these are relatively inexpensive to buy and sell, which is why theyre a great way to hedge your portfolio. Any broker will be able to take care of this for you.

Its important to understand that leveraged VIX ETNs do have some drawbacks. Due to the repositioning that will occur within your portfolio theres such a thing as volatility lag, which will hurt your performance. While these are closer to replicating the VIXs actual performance, it will only be effective for a short time period.

The VIX Using the Uncertainty Index for Profit and Hedging

VIX Futures and Options

More advanced investors can also trade futures and options on the VIX. These provide greater leverage and return on successful trades. Of course, there are some factors that need to be kept in mind. To begin with, options and futures tend to carry higher commissions than equity trades. Therefore, its important to always maintain a minimum margin and know the different tax treatments in regards to gains as opposed to losses. This is especially true whenever youre dealing with future contracts. Its just as important to understand that both options and futures have a definite lifespan. So, as an investor you not only have to concern yourself with the volatilitys direction but you also have to concern yourself with this lifespan as well.