Exploring Volatility Indices: VIX and MOVE
Article by Fabrizio Dimino
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Overview
The VIX (Volatility Index), also known as the fear index or fear gauge, is a widely followed volatility index in the financial market. It was introduced in 1993 by the Chicago Board Options Exchange (CBOE) and is designed to measure market expectations of future volatility in the S&P 500 index. The VIX index is often referred to as the "fear index" because it tends to rise when investors are concerned and the stock market is volatile. More specifically, the VIX index measures the implied volatility of options on the S&P 500 index. Options are financial instruments that give holders the right, but not the obligation, to buy or sell an asset at a predetermined price within a specified expiration date. A high level of the VIX index, indicating increased expected volatility, can be interpreted as a signal of uncertainty or nervousness in the stock market. Conversely, a low VIX level indicates lower expected volatility and a higher degree of stability in the market. The Merrill Option Volatility Estimate (MOVE) index is an indicator used to measure the expectation of future volatility in the government bond market, particularly for U.S. Treasury bonds. When the MOVE index rises, it indicates an expectation of greater volatility in interest rates, which can have a significant impact on the price of government bonds. In other words, an increase in the MOVE index suggests that traders expect interest rates to be more volatile in the future.
The VIX and MOVE during crisis
As a general idea, during periods of stability in the financial markets, the VIX and MOVE tend to remain at relatively low levels. The VIX typically ranges between 10 and 20, while the MOVE remains below 100. However, during times of crisis or events that generate significant uncertainty, such as an economic recession or a significant market correction, the VIX and MOVE can reach much higher levels. For instance, during the 2008 financial crisis, the VIX reached peaks above 89, while the Move more than 264. More recently, during the COVID-19 pandemic in 2020, the VIX reached levels around 80-85, and in March, the MOVE went above 198. When the VIX and MOVE are low, it may indicate a period of lower volatility and greater stability in the financial markets. During such periods, some investors may seek investment opportunities that tend to benefit from a less volatile environment, such as stable company stocks, high-quality bonds, or index funds (ETFs) that track the performance of a broad and diversified market.
How to invest in them
As of this date, it is not possible to invest directly in the VIX and MOVE themselves. However, it is possible to gain exposure to volatility using ETFs, such as the iPath S&P 500 VIX Short-Term Futures ETN, as well as derivatives like VIX futures and options. VIX futures enable investors to speculate on the future movement of the volatility index: by purchasing a VIX futures contract, an investor can profit if the index increases in value. VIX options provide another way to obtain exposure to volatility. VIX call options allow investors to bet on the increase in the index’s value, while VIX put options enable betting on a decrease in its value.
When the VIX varies
The VIX is negatively correlated with the S&P 500: if the S&P 500 rises, the VIX falls, and vice versa. So, rather than a specific market anticipating the VIX, it is the behavior of investors in the S&P 500 options market that influences the value of the VIX. When investors buy a significant number of options to protect their stock investments, it can drive up the price of options and consequently increase the value of the VIX. If investors anticipate an increase in future volatility of the index, they may purchase more protective options, thereby pushing up the value of the VIX. Furthermore, periods of high volatility and uncertainty do not necessarily represent the right time to sell. During such periods, markets can experience sharp and rapid movements, but it also presents opportunities for investors with higher risk tolerance. Investors who can remain calm and make rational decisions can capitalize on these situations, achieving higher long-term returns.