What moves the VIX?
December 30, 2014
- At the end of January a blog was published explaining how the VIX is calculated. In short, the VIX is based on the premium traders are paying for options protection. For this reason, the VIX usually moves conversely to the market: when stock prices drop, traders demand more protection, prices rise and subsequently the VIX increases in value, and vice versa.
- VIX contracts are currently trading at multi year lows, making this a good time to discuss catalysts that have been driving the VIX lately. Traders can use this information to set up hedges and take advantage of situations where the VIX could significantly swing.
- Over the past several months, when equities start to turn down, and subsequently volatility rises, the Federal Reserve has been putting bullish information into the market. These releases can come in the form of ZIRP continuation, no increase in tapering and other dovish remarks.
- The release of the FOMC meeting minutes are a key day to watch for this change. The last two FOMC releases were on May 21 and April 9. The VIX fell 2.4 percent and 4.7 percent, respectively. Other events to watch for are Federal Reserve members speaking, with Janet Yellen, of course, being the most influential.
- Gold is often held for stability. For example, when tensions were heating up between Russia and the West, gold spiked in value. A big part of this was Russian citizens and corporations selling the Russian Ruble because of its instability and buying gold to diversify away risk associated with the conflict.
- However, when gold becomes more volatile, it loses its ability to act as a hedge. Gold instability can move the VIX higher for two reasons. First, when investors need a hedge, they may feel safer buying options security, which directly moves the VIX higher. In addition, gold miners will be volatile due to gold price swings, and options security will likely be purchased to protect those positions.
- Along with the VIX, treasury yields are at multi year lows. This means that demand for bonds is very higher, also implying that funds that typically may be in equities are currently in bonds.
If bond prices start to drop and money flows back into equities, options protection is likely to naturally increase as investors take positions in a less secure asset class.
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