Volatility advances markets as reliably as price or volume, expanding and contracting over time in reaction to greed and fear. Periods of important volatility reflect high risk, high reward environments, in which perfect timing can book impressive profits while proceed d progress it wrong can trigger severe losses. Many market players avoid price prediction entirely during stressful years, instead placing bets on the direction of volatility through VIX futures or specialized equity funds that react to those reduces. While profiting from these instruments requires sophisticated skills, the payoff is worth the effort, especially when volatility is drifting strongly, higher or lower.
Key Takeaways
- Some investors avoid price prediction entirely during stressful aeons, instead placing bets on the direction of volatility through VIX futures or specialized equity funds.
- While VIX futures extend the purest exposure to volatility’s ups and downs, volatility funds attract far more volume because they’re easily accessed fully equity accounts.
- Some of the most traded volatility products include VXX, VXZ, UVXY, and TVIX.
Created in 1993, the CBOE Call Volatility Index (VIX) provides real-time snapshots of greed and fear levels, as well as expectations for volatility in the next 30 meetings. It provides the basis for futures pricing, as well as strategies that market timers can use to time entries and exits into volatility-based neutrality funds. Introduced after the 2008 economic collapse, these complex instruments have grown enormously favourite for both hedging and directional plays.
Buying and selling of these securities have generated a leadership effect on the VIX summon and VIX futures contract in recent years due to their enormous volume. You can see this happen when funds break out, set up down, and reverse ahead of the underlying indicator. This effect is most prevalent in highly volatile market outfits.
Trading Instruments
While VIX futures offer the purest exposure to volatility’s ups and downs, volatility funds attract far more size because they’re easily accessed through equity accounts. Rather than Exchange-Traded Funds (ETFs), varied of these instruments are Exchange-Traded Products (ETPs) that utilize complex calculations layering multiple months of VIX days into short- and mid-term expectations.
Volatility Funds
- iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX)
- iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZ)
- ProShares VIX Short-Term Approaches ETF (VIXY)
Inverse/Leveraged Volatility Funds
- ProShares Short VIX Short-Term Futures ETF (SVXY)
- ProShares Ultra VIX Short-Term Futures ETF (UVXY)
Real-time consequence of funds decays through contango, which reflects timing variations between a futures contract and spot fees. These calculations can squeeze profits in volatile markets, causing the security to sharply underperform the underlying indicator. As a follow, they work best in short-term strategies that utilize aggressive exit techniques, long-term strategies, and hedges, and in blend with VIX futures and protective options plays.
VIX Analysis
Volatility fund strategies require a two-step approach that inspects VIX as well as price action on the targeted fund. An understanding of VIX technical analysis can mitigate the profit-dampening effect of contango by connecting levels and turning points where funds will lose trend momentum. It works because longer-dated tomorrows contracts used to calculate pricing are less sensitive to short-term VIX movement, exerting a greater effect when bias momentum wanes.
The VIX chart generates vertical spikes that reflect periods of high stress, induced by financial, political or environmental catalysts. It’s best to watch absolute levels when trying to interpret these jagged representations, looking for reversals around big round numbers, like 20, 30 or 40 and near prior peaks. Also pay distinction to interactions between the indicator and 50- and 200-day EMAs, with those levels acting as support or resistance.
Maintain a real-time VIX on your screens when considering entries into volatility funds. Compare the trend with cost action on popular index futures contracts, including the S&P 500 and Nasdaq 100. Convergence and divergence relationships between these thingumabobs generates observations that assist in market timing and risk management:
- Rising VIX + rising S&P 500 and Nasdaq 100 catalogue futures = bearish divergence that predicts shrinking risk appetite and high risk for a downside reversal.
- Be generated VIX + falling S&P 500 and Nasdaq 100 index futures = bearish convergence that raises the odds for a downside swing day.
- Falling VIX + falling S&P 500 and Nasdaq 100 index futures = bullish divergence that predicts growing jeopardy appetite and a high potential for an upside reversal.
- Falling VIX + rising S&P 500 and Nasdaq 100 index futures = bullish convergence that brings odds for an upside trend day.
- Divergent action between S&P 500 and Nasdaq 100 index futures lowers predictive reliability, instances yielding whipsaws, confusion and rangebound conditions.
Measure volatility trends with long- and short-term VIX charts, looking for sympathetic bread plays. Rising VIX tends to increase the correlation between equity indices and underlying components, making long-side support exposure more attractive. Falling VIX reverses this equation, supporting short-side entries that require profit-taking while VIX indemnities to longer-term averages.
The Bottom Line
Volatility funds offer exposure to high “greed and fear” levels while dodging predictions on price direction. Complex fund construction makes them best suited to short-term trading designs in volatile conditions and long-term short-side strategies in benign and quiet conditions, including bull market environments.