VIX Vapo Rub

Anyone that is my age can fondly remember getting a cold. Mom or dad would quite often pull out the Vicks Vapo Rub. The smell of that shit still haunts me to this day. It is the one smell almost everyone can identify instantly.

The VIX we are talking about today though is exactly the opposite of calming and soothing – in fact the VIX we are talking about today is the kind of thing that causes you to reach for something a little stronger – Johnnie or Jack perhaps.

Why in the hell am I talking about an investment product on a mortgage blog you ask? Well, whenever I get a lot of questions about one particular thing, it usually indicates people need a little clarity. I have been overwhelmed with emails, messages, and comments about the VIX. So let’s explore.

The VIX is actually known as the Volatility index. It is quite commonly referred to in investment circles as the ‘ fear gauge’. The common explanation is as follows:

The Volatility Index or VIX is the annualized implied volatility of a hypothetical S&P 500 stock option with 30 days to expiration. The price of this option is based on the prices of near-term S&P 500 options traded on CBOE

Now that we have the proper answer out of the way, lets see what it means:

The VIX is a tradeable security that is used to measure the implied volatility of a market – in most cases the S and P 500. This is done by measuring the difference between put and call ratios on the Chicago Board Options Exchange. Puts and Calls are effectively bets on whether a given market with go up, or go down, in a set period of time. If you think a market will go up, you would buy a call option, and if you think a market will go down, you would buy a put option. I won’t dig into the world of options any further here, as that would take a year of blogs to unpack. An option is just a bet on the direction you think a market will go. If I thought RBC stock was going to go up, I would buy a call option on it, and if I thought RBC stock would go down, I would buy a put option. The difference between the number of put options vs call options is what the VIX is basically derived of. They key here is that VIX indexes are short term forward looking. The VIX will not do much to tell you what will happen 6 months out, 1 year out, 10 years out, etc. A general rule of thumb is that the VIX will give you a window of about 30 days.

There are many versions, variations, and vehicles that the VIX can be made up of, since it is measuring the put/call ratio on a specific market. You could for example build a VIX product simply around banks stocks. I could take the publicly traded stocks of Canada’s big 5 banks, measure the put to call ratio, and develop a VIX index specific to bank stocks. No one would do that, because there really isn’t enough volume to make it effective, and it is very sector specific. The larger and broader the market – the better the VIX will be at tracking the sentiment. The most common VIX you will hear quoted is the CBOE VIX market, and that is the measurement of the S and P 500. This makes a lot of sense, as the S and P 500 tracks the 500 largest stocks in the US ( worlds largest market ). Using the S and P 500 gives us a lot of volume, a lot of trading, and a good measure across a wide variety of sectors.

If you want to track the VIX, you can simply type VIX into Google, and the first search result will be the CBOE VIX futures. Generally the VIX readings mean:

 0-15: This can indicate a certain amount of optimism in the market as well as very low volatility.

15-25: This can indicate that there is a certain amount of volatility, but nothing extreme.

25-30: This can indicate that there is a certain amount of market turbulence and volatility is increasing.

30 and over: This can indicate that the market is highly volatile and there may be some extreme swings soon

If you go and look at a chart of the VIX over the last 20 years, you will see that the extreme readings on the VIX line up with major world financial events.

A couple things to keep in mind though with the VIX:

1. The VIX will tell you about volatility in the markets, but that doesn’t mean it is always a good indicator of the market direction. If markets were to slowly drift lower and lower and lower, the VIX would remain fairly low, as a dropping stock market is not the same as volatility. What we saw this week was wild volatility. The VIX was high, and that made sense. If the market simply eroded and lost 1% a month for the next 24 months straight, that is not volatility, that is just a downward slide.
2. This is important, and I can not stress this enough. DO NOT TRADE THE VIX UNLESS YOU ARE A PROFESSIONAL!!!!!! Mortgage brokers seem to have this knack for chasing the latest, greatest investment ( bitcoin, real estate, crypto, NVIDIA, etc. ), but you will get your ass handed to you if you try and invest in the VIX. Since the VIX measures 30 day implied volatility there is a lot of ‘ leakage’ in the data when the 30 day options reset. This can cause you to lose your shirt in a hell of a hurry. Even if you are right, and the VIX goes up, due to option expiration resets, you can still lose all your money. VIX trades are often levered trades, so it can wipe out your entire investment in a heartbeat.
3. VIX futures will explode at exactly the time that volatility explodes. They will creep higher into an event, but by the time you wake up and see the volatility in the overnight session in Asia and Europe, it is too late as the VIX has spiked already.
4. VIX futures and VIX markets are most commonly used by professional traders as a hedge. If I ran a fund that had a lot of economically sensitive stocks in it, I would use VIX futures as a hedge in case a world event like, oh, let’s say COVID, came along and kicked the stock markets ass. When everything is cratering, the VIX will be up, so it will help level out my positions, and make my performance a little better. I can also use the profits from selling my VIX position to buy battered, beaten up stocks. Outside of this, there is not a lot of demand from retail traders, do it yourselfers, and mom and pops day traders – and so it should be.
5. Surprises can cause the VIX to oscillate. Last week’s US employment report was a good example. The market expected one thing, and got another. When this happens it can cause the VIX to move quite rapidly – or not at all. However, the larger the surprise, they larger impact the surprise will have on the VIX. Surprises don’t have to move all markets, but it can move the VIX around.

The VIX is just one more thing that you can keep you eye on to help you build a case as to where things may be going in the short term. If you start to see the VIX creeping up, then it may be a reason to do a deeper dive on your assumptions, talk to people in the know, and stress test your theories about where you think the economy, housing, interest rates etc. may be heading. For example, at the beginning of July 2024 the VIX was sitting around 11.84. That is kind of a low vol, unexciting world. However, by July 22nd it had crept up to 14.82. Still below 15, but up about 25% from early July. By July 30 it was up to 17.69. By Aug 5, it was 38.57. Shit changes fast in finance, but anyone who kept one eye on the VIX had a pretty good feeling something was coming. This week was that something. Today we sit at 23.79, so down 38.3% from Monday, but still elevated.

The VIX is not bullet proof, and has given some false positives in the past. I like to kid that the VIX has called 48 of the last 20 problems. However, it can be a useful tool for anyone even remotely associated with finance to help gauge where they think things may be headed. Remember volatility happens in stocks, in bonds, in crypto, in currencies ,and in housing markets. The VIX will only measure whatever specific market it is tied to. Tying the VIX to the S and P 500 is a pretty good indicator if things to come. If you start to see the VIX chugging higher, it is probably a good indication that something is coming. Be prepared for it, and more importantly be the rock that your clients need in the financial shit storm that may be coming.