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Over the past two years the Chicago Board of Options Exchange Volatility Index, or VIX, has probably become one of the most over-referenced and misunderstood gauges in the financial community. And in an investment world that pays heed to some pretty bizarre and tenuous indicators, that’s saying a lot. Still, like cliches being true, tracking implied volatility levels presents a variety of trading and hedging opportunities that can be implemented by trading the VIX-based products directly.

The basic misunderstanding is the view that the VIX is strictly a contrary indicator, and the biggest misuse is in constantly trying to assign or divine predictive meaning from daily changes in the level of the VIX.

For over a year now this has come in the form of citing its low reading as a sign of general complacency that indicates the market is due for a selloff. The fact is the VIX, which has been trending down for over three years and hit decade lows this past February, has never been a good instrument for calling market tops. It is much more effective at flagging market bottoms.

As options guru Larry McMillan, president of McMillan Analysis, points out: For a measure to provide a contrary signal it needs to demonstrate that all participants are in agreement about the future direction, and right now that is simply not the case.

The VIX has essentially been tracking the historic or real volatility of the underlying index pretty closely for most of the past year. In the last three weeks the VIX has shot up some 30% to 14.55%, it highest level on over two months. But note during this same period the SPX’s 20-day historical or actual volatility has risen from 8.10% to 11%, a commensurate 35% increase.

When the VIX hit an 11-year low last February, it coincided with a bottoming of the historic volatility in the index. The fact that the VIX is actually sporting a premium, which should be expected at such low levels, makes it hard to make the blanket statement that the VIX is too low or showing signs of complacency. It makes it especially challenging to choose a directional bias on the underlying index based on a low VIX. If you had been doing nothing but buying option premium or shorting the stocks for the last two years that we’ve had a low VIX, you’ve probably had a tough time making money.