Learn to Trade Emini Futures - Using The VIX / $VIX

by DeWayne Reeves

What is the VIX?

The VIX is the CBOE market volatility index. It is essentially a measurement of expected market volatility over the next 30 days. Volatility appears to increase when investors are "worried" about the markets and by extension have become uncertain about what the immediate future may hold. This is why you will often hear the $VIX referred to as the "index of fear".

How is it Calculated?

It is simply a calculation of the anticipated movement (in % points) of the SP500 index over the next 30 days. It is calculated by observing the variances in option strike prices from the current and next months of expiration (using SP500 index options). The calculation takes the difference, annualizes it, and then quotes it as a %. The basic concept behind the formula is that as option prices change, the underlying futures contracts are pricing in traders' forecasts for price moves going forward. As such, it gives us a view of anticipated fluctuation in the SP500 over the next month. The greater the difference, the greater the "fear" being expressed by market participants.

How Does it Work?

The VIX works in this manner based on the reasons why investors buy or sell options on the SP500 index. Individual investors tend to trade options on individual stocks or ETFs because they are speculators--buying options because they are of the opinion that the equity itself is either going up or down in the short term. SP500 options, however, are a popular tool used by institutions to hedge their portfolios, which is more about risk control rather than it is about speculation.

Understanding the Chart

When analyzing a chart of the $VIX take special note of two critical pieces of information:

1) The current high or low of the index as it relates to the recent past

2) What is the range between current support and resistance levels?

The most common assumptions are as follows:

• When the $VIX reading is above 25 anticipate market conditions to be more volatile and be prepared for a possible correction or downturn. When the reading is below 20, conditions are considered more stable thus the potential to develop an upward trend exists.  The difference between support and resistance levels on the SVIX are likely to be much larger at higher values. When the $VIX is above 25 the anticipated range is approximately 15 points.
  
• When the $VIX reading is below 20, look for trading range in the neighborhood of 5 to 7 points. Leep in mind that the smaller the $VIX range, the more complacent investors and traders tend to be. A complacent or comfortable market (retail or institutional) is more likely to be stock buyers creating the potential for an upward trend.
  

Applying the VIX to Your Emini Futures Trading

Traders must first look at current market conditions based on their observation of what the  $VIX is conveying, and then make their best trading decisions accordingly. Examples:

• Traders may adjust the number of positions they have open at the time
  
• They may asses how long they expect to hold those positions
• They will typically adjust stop-loss orders to protect any open position.

Along with giving insight to current market conditions, the $VIX also helps to provide a "heads-up" when market conditions may be changing. This can assist traders in identifying when a bullish market might be overbought and is beginning to reverse its direction, or "correct," or in a worse case scenario, do more than correct and actually turn into a genuine Bear market. In the chart below you will see the $VIX and the $SPX compared. Observe where the VIX spiked up through its current range. You can see how these spikes provided the "heads up" that a potential decline was possible on the SP500 index. These $VIX spikes can help traders and investors in their decision making process such as when it mat be time to reduce risk on an open position or to take profits and close the position entirely.

Based on our interpertation of the above chart and information below, the $VIX is presenting a Bearish Outlook. This includes Emini Day Traders as well as Swing Traders and longer term Equity Investors.

CBOE Volatility Index ($VIX)

18.28    -1.59 (-8.00%)   Friday, Jan 20th, 2012

Composite Indicators	Signal
TrendSpotter			Sell
Short Term Indicators
7 Day Average Directional Indicator			Sell
10 - 8 Day Moving Average Hilo Channel			Sell
20 Day Moving Average vs Price			Sell
20 - 50 Day MACD Oscillator			Sell
20 Day Bollinger Bands			Sell
Short Term Indicators Average: 100% Sell
Medium Term Indicators
40 Day Commodity Channel Index			Sell
50 Day Moving Average vs Price			Sell
20 - 100 Day MACD Oscillator			Sell
50 Day Parabolic Time/Price			Sell
Medium Term Indicators Average: 100% Sell
Long Term Indicators
60 Day Commodity Channel Index			Sell
100 Day Moving Average vs Price			Sell
50 - 100 Day MACD Oscillator			Sell
Long Term Indicators Average: 100% Sell
Overall Average: 100% Sell
Price Support Pivot Point Resistance 18.28 17.01 18.79 20.57

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