Ways To Profit If Wall Street’s Fear Gauge Spikes

Ways To Profit If Wall Street’s Fear Gauge Spikes

about 4 years ago2 mins

Investors’ expectations of future stock market volatility hit the lowest level in more than a year last week, but have since rebounded sharply as they were reminded that global trade tensions aren’t going away just yet.

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What’s does this mean?

The volatility index, known by its VIX ticker and referred to as Wall Street’s “fear gauge”, is used to assess the level of concern in the market. A low VIX reading indicates calm markets, whereas a high one indicates investor panic. The index has had an average value of 18 over the last 15 years, and hit a peak of 89.5 in the 2008 crash.

Why should I care?

Well, you can trade the VIX with the aim of making a profit – just as you can with any other investment. Buy VIX if you think volatility is going to rise and go short VIX if you think volatility is going to fall.

In addition, you can buy the VIX as a “hedge” – i.e. protection – against falling markets. That’s because VIX tends to spike up during rapid market sell-offs, offsetting any losses from stocks.

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Buying the VIX isn’t as simple as it first appears, however. Professional money managers use futures contracts to bet on its direction – but brokers often block retail investors from accessing these instruments as they’re leveraged and losses can mount quickly.

It’s much simpler to access the VXX exchange-traded fund (ETF), which invests in VIX futures. A word of caution though: because futures contracts have expiry dates, the ETF has to constantly reinvest its funds into newer contracts that are typically more expensive than VIX’s current value. This constant “rolling over” of futures is costly and means the VXX doesn't make a good long-term investment – it will lose value over time even if the VIX stays absolutely flat. So don’t think of the VXX as an investment to hold over the long term, just something to use opportunistically.



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