How to take advantage of the volatility to invest in the stock market?
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 In this article, you will discover the definition and the method of calculating volatility and its index, the Vix, better known as the fear index. We will also present the different financial products that allow you to trade and take advantage of volatility.


What is volatility?

Over time, financial assets are characterized by periods of greater or lesser volatility depending on different elements such as the macroeconomy, different company economic events, political news, institutional buying or selling movements, etc.


In financial markets, many factors explain periods of volatility, but there are also phases of volatility that cannot be explained rationally. Volatility is used as an indicator to measure the level of risk and is distinguished by two main factors: amplitude and time.


Amplitude is the difference between a low and a high point:


In this example, the financial asset begins with a bullish peak at +45% before dropping to a low of -30% and then recovering. The amplitude between the high point (+45%) and the low point (-30%) is therefore high, at 75%.


In your opinion, is this financial asset volatile? Not necessarily, as this will depend on the time factor. If this 75% amplitude is achieved over a very long period of 20 years, the asset will not be considered volatile. On the other hand, if this variation is carried out over the short term, during a few months for example, then the asset will be considered very volatile.


In conclusion, the volatility of a financial asset is characterized by the combination of time and amplitude of the variations in the asset's price.


What is Vix? The volatility index or the fear index

Widely followed by analysts around the world, the VIX is the benchmark for measuring volatility in the US markets. It is an indicator that is calculated and published by the CBOE (Chicago Board Options Exchange), the exchange where the most options are traded in the US, and this is no coincidence, as the measurement of volatility is very important for options traders, especially for calculating the amount of the option premium.


The VIX measures the volatility of the US S&P 500 index. The higher the VIX, the more volatile the S&P 500 is, and vice versa. Beyond the S&P 500, since the U.S. markets often "lead the way" in terms of global stock markets, the VIX is often taken as a benchmark for overall market volatility.


For information, although it is much less used, the equivalent of the VIX for Europe is the VSTOXX (EURO STOXX 50 Volatility).


Over the last 20 years, the VIX has exceeded 80 twice: during the 2008 financial crisis known as the "subprime crisis" and in March 2020 during the "covid crisis".


The VIX mainly indicates the volatility of equity markets. However, equities are not the only asset class to experience volatility and all other asset classes can be confronted with it: bonds, commodities and agricultural products, derivatives, crypto-currencies, real estate, art, luxury goods, etc.


For the record, in 2011 the CBOE created a second index, the VVIX, which aims to measure the expected volatility of the VIX itself. An initiative that follows the fact that the VIX is now more than a simple indicator, it is also an asset increasingly traded with derivatives.


The method of calculating the VIX

The method of calculating the VIX is relatively complex and mathematicians can find the formula directly on the CBOE website.



For your information, here is the mathematical formula:

The key thing to remember is that the VIX is calculated by averaging the annual implied volatility of calls and puts on the S&P500. The higher the option price, the higher the volatility.

The VIX is expressed as a percentage deviation from the standard annual return of the S&P 500.

Implied volatility is a close approximation of historical volatility calculated directly from the movements of the S&P 500 index.

The most common interpretation by analysts using the VIX is as follows:

- Between 10 and 15, the volatility of the S&P 500 is low;

- Between 20 and 30, volatility becomes more pronounced, making the market nervous;

- Above 30, there is high volatility and the market may enter the "fear" or high anxiety zone.

It is important to analyze the direction of movement rather than the absolute value of this index. The higher it goes, the more nervous the market becomes. Like all indicators based on an average price, it is also important to keep in mind that the VIX is not necessarily a good indicator for predicting future movements, but rather for observing the evolution of a situation.

History of the VIX Index since its creation in 1986

Since 1986 and throughout the major crises of the last 30 years, the VIX has experienced extreme periods.

We can list 6 dates during which the VIX has exceeded the value of 50 :
  • During the crash of October 1987 (VIX: 150)
  • During the Russian financial crisis of October 1998 (VIX: 60)
  • During the attacks of September 11, 2001 (VIX: 58)
  • During the financial manipulation affair with the bankruptcy of Enron (VIX: 58)
  • During the subprime crisis in 2008 (VIX: 59)
  • During the Covid crisis in March 2020 (VIX: 82)

How to trade the VIX?

As we have seen, the VIX is no longer simply an indicator to help analysts measure market anxiety but is now a financial product that can be traded in a variety of ways.

VIX Index Option

Investing in options on the VIX has been available since 2006 and is used as a hedge in portfolios.

There are two types of options on the VIX:
  • Call: call option to anticipate the rise of the VIX
  • Put: a put option to anticipate a drop in the VIX
Thus, traders who are used to trading options will be able to speculate on the rise and fall of the index. They will be able to use the VVIX to help them analyze whether it is better to buy a call or a put, or whether the right strategy is to sell a call or a put.

VIX Futures Contract

While options are great for hedging or swing trading strategies, traders who want to implement day trading or scalping strategies may want to consider VIX futures contracts.

Futures contracts offer sufficient liquidity and reasonably low spreads to allow them to be used in many strategies, including very short-term strategies (e.g. order book trading).

VIX CFDs

Replicating VIX futures contracts, or directly the VIX index, CFDs allow less capitalized investors to also trade the VIX, knowing that the minimum amount on a CFD is much lower than on a Future contract. CFDs also allow the use of leverage for traders who are able to accept a higher risk.

What financial investments should I use to bet on volatility?

Mutual funds specialized in volatility

There are mutual funds (Undertakings for Collective Investment in Transferable Securities) that focus on volatility. With their teams of expert managers in this sector, they aim to generate performance via financial products based on volatility.

Examples include the Allianz Volatility Strategy Fund IT EUR Cap or Amundi Dynarbitrage Volatility IC.

Hedge_funds_specializing_in_volatility

Some hedge funds focus their strategies on volatility-related financial assets, such as the LJM Partners Preservation and Growth hedge fund. The latter actually lost 82% of its assets under management (US$1 billion) in just a few days following the unexpected rise in the VIX in February 2018.

The US speculative hedge fund specializing in volatility Options Solutions LLC of Man Group Plc also experienced setbacks in early February 2018 with losses of up to 65% of its total assets under management, and as a bonus, the obligation to sell positions.

Case-by-case asset selection can offer higher levels of volatility than VIX options or volatility-driven alternative mutual funds and hedge funds, some recent examples of which include:

GENSIGHT BIOLOGICS stock

French stock Gensight Biologics saw its share price rise from $1.10 at the end of 2019 to a high of $10.05 in May 2021, then fall back to $1.80 in May 2022, and currently sits around $3.78. 

US oil prices (WTI)

The oil price is also very volatile, especially since the beginning of 2022, as it gained 68% of its value between the beginning of January and mid-March 2022, and finally suffered a 39% drop from March 2022 to October 2022.

Bitcoin and cryptocurrency

Let's also not forget crypto-currencies, one of the most volatile assets of the moment, whose ranges of variation were very intense between November 2020 and June 2022.

Bitcoin's price against the U.S. dollar went from USD 15,000 in November 2020 to a high of USD 64,000 in April 2021, before dropping to USD 30,000 in June 2021. After that, Bitcoin's price quickly recovered to hit an all-time high of USD 68,000 in November 2021, only to fall back to less than USD 20,000 in June 2022.

As mentioned above, other asset classes can also be subject to volatility such as bonds, derivatives, real estate, or more specific markets like art, luxury, wine, etc.
However, investors wishing to use a specific financial asset to take advantage of its volatility, such as a historically volatile stock, for example, will need to have a very high level of expertise, as past volatility does not prejudge future volatility!

Moreover, you have to position yourself in the right direction! It is therefore necessary to be very vigilant with this type of highly speculative approach.

Image sources: Freepik

All our information is, by nature, generic. It does not take into account your personal situation and does not constitute in any way personalized recommendations for the realization of transactions and cannot be assimilated to a service of advice in financial investment, nor to any incitement to buy or sell financial instruments. The reader is solely responsible for the use of the information provided, without any recourse against the publishing company of Cafedelabourse.com being possible. The publishing company of Cafedelabourse.com cannot be held responsible for any error, omission, or inappropriate investment.

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