What is the VIX? How you can profit from stock market volatility with Wall Street’s ‘fear index’

You may have noticed unusually volatile fluctuations in the value of your investment portfolio or pension over the last month. 

The FTSE 100 has just about recovered ground after kicking off August by following other major markets with a sharp sell off that wiped $6.4trillion (£5.03 trillion) from share prices globally.

Most experienced investors will tell you the best policy during a sudden sell-off is to hold your nerve – often selling up is the quickest way to losing money.

But there’s also a way for investors to profit from intense bouts of volatility.  

The VIX aims to track the expected volatility of the S&P 500 index, based on data from option contracts

What is the VIX?  

The CBOE Volatility Index, or VIX for short, acts almost like a barometer of investor confidence. 

The closely-watched index, which launched in 1993, aims to track the expected volatility of the S&P 500 index, based on data from option contracts. 

There are two types of option. A ‘call’ which gives the holder the right to buy a share (or other asset) at a set price in the future, and ‘a put’ which gives the right to sell. 

The index measures the market’s expectation of how much the price of major stocks will move in the next 30 days.

When the VIX is high, investors expect volatility and major price swings in the market, which is prominent in times of uncertainty. 

When the VIX is low, investors expect minimal price movements and stability in the market. 

How can UK investors invest in the VIX?

Investment opportunities in or around the VIX are very limited.

One option is via VIX Futures, which according to Sam North, market analyst at eToro, might not be for every investor ‘as a significant margin is needed to trade it’. 

David Morrison, senior analyst at Trade Nation says that the best way for British investors to speculate on the VIX is by using VIX exchange-traded funds (ETFs). 

North explains that ETFs allow investors to track the VIX thus providing traders exposure and a tool ‘to hedge against future volatility in the markets’. 

He continues: ‘Separately, some investors will just purely use the VIX as a gauge for their other investments. 

‘For example, a high VIX might indicate a good time to buy puts on the S&P 500 or other indices, or to reduce equity exposure, while a low VIX might suggest a more stable market where increasing equity positions could be beneficial.’

eToro has ETFs that offer exposure to the VIX, such as UVXY and VXX. They also offer VIX Futures. 

Whereas on Trade Nation you can trade the VIX as a spread bet or CFD. 

What risks should investors be aware of before investing in the VIX?

Clearly, investors should be wary of the volatility of the VIX when buying an ETF.  

According to North, liquidity should also be considered by investors.

He said: ‘While some ETFs might have good liquidity, not all do, and therefore when volatility increases, so does the spread which means investors might not always be able to get in and out at their desired prices.

‘If the S&P rises, VIX-related assets usually fall and vice versa. These factors make VIX investments particularly challenging, requiring a nuanced understanding of futures markets and volatility dynamics.’