VIX and the S&P 500

Go to a computer and log on to a free charting service such as FreeStockCharts.com and click the New Price Chart tab at the top of the screen. Input VIX as the symbol to pull up the price chart for the VIX itself. Take note that the VIX has an inverse relationship with the S&P 500, which means that as the S&P 500 is falling, the VIX is rising. The VIX rises because herds of traders are buying put options in the S&P 500, which drives up the price of the VIX.

Bollinger Bands

Click the Indicator tab again and select the Bollinger Band indicator, which will overlay the price action on the VIX with a median line in the middle, with two bands outside the range of the price action itself. John Bollinger, inventor of the Bollinger Bands, discovered that that price action had a tendency to revert to its average price after fluctuating up and down from that baseline. The Bollinger Bands calculate the volatility at a 2 standard deviation setting. This is important when using the VIX as an indicator because once price reaches one of these bands, it helps you measure whether the VIX is revealing an extreme sentiment in the market.

The Setup & Trigger

Watch the VIX as it begins to rise due to the S&P 500 falling in price. When the VIX reads a 90 or above in the RSI, then confirm the extreme sentiment when the VIX moves up into the upper area of the Bollinger Band on your price chart. Once those two indicators read at extreme levels, wait for the next VIX price bar to trade and close down. If the following VIX price bar closes down below the low of the preceding bar, then buy the S&P 500 call options and exit when you hit your profit target.

Crowds are Often Wrong

References

Resources

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