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I do have a basic understanding of the Volatility Index (Chicago Board Options Exchange Market Volatility Index), but I wasn't sure how this index is best used by an individual, average investor.

From what I can gather, you basically buy it when you think there will be a big price change and sell once that turbulent time has passed (i.e. to hedge the risk of your portfolio). Isn't it true though that you can largely achieve the same effect by using futures/options?

I guess the difference is that in VIX it doesn't matter if the market goes up or down, and I can imagine wanting to buy something like that. But if my understanding is true, when should I consider buying/selling, and how much?

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Read Examining VIX ETF Performance During A Sell-Off. The VIX is an index and can't be traded directly. Similar to the fact that you can't really buy the S&P index, you either try to replicate it yourself, or buy an ETF. The VIX ETFs, per this article, don't correlate 100% to the VIX itself.

Not to be snarky, but specific to your question "how this index is best used by an individual, average investor" the answer is "it's not." The idea that you can buy and sell such a derivative with an eye toward hedging your average portfolio is pretty ambitious and would probably cost you in the end while not providing the insurance you believe you are getting.

If you have a sufficiently large portfolio, broad market Put options would get you what you seek, but still, at a cost. The truly average investor needs to use asset allocation as a means to tune their overall risk, long term.

  • I've noticed that about the ETFs that relate to it (like the VXX, VXZ). However, unless Yahoo has produced incorrect information, looking at this link (here: finance.yahoo.com/…), wouldn't you say that when the VIX goes below 11, it becomes risking to not play a move? – Question3CPO Dec 4 '13 at 19:53
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The VIX is just a weighted sum of options prices (see white paper). The weights are set so that the index represents something called model-free implied volatility. You can trade future levels of the VIX using VIX futures, or you do this indirectly by buying or selling ETFs which hold VIX futures. You should use it as you would use any other financial or economic time-series, as an indicator of the state of the world at a given moment in time. Depending on your investing style, it may or may not be useful to know what level of future volatility the market is expecting. You should consider buying or selling VIX derivatives whenever your view differs from the market's.

  • As I understand VIX, it's an instant snapshot of volatility. The week the S&P was up or down 50 points each day the VIX was high. If the S&P fell one point per day, everyday for a year, it would've dropped 20% in that time, but the VIX would have trended down. It seems impractical for an average investor to use this instrument in any practical manner. – JoeTaxpayer Sep 26 '11 at 16:49
  • VIX is an instant snapshot of 30-day implied volatility, and is only indirectly related to realized volatility. For example, if a boring consumer goods company has some pending lawsuit which will either make the company either fantastically profitable or bankrupt, implied volatility can be much greater than realized. – Tal Fishman Sep 26 '11 at 17:01
  • I don't mean to be dense, just trying to understand. How would the OP use VIX to "hedge risk"? – JoeTaxpayer Sep 26 '11 at 20:05
  • @JoeTaxpayer see here and here. Or google "volatility as an asset class" and read the myriad of stuff that comes up. – Tal Fishman Sep 26 '11 at 20:16

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