How to Understand the Volatility Index

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Use VIX to determine market stability.
Use VIX to determine market stability. (Image: Spencer Platt/Getty Images News/Getty Images)

The Chicago Board Options Exchange's Volatility Index, also known as the VIX, shows market expectations for S&P 500 index options during a 30-day period of time. VIX was first introduced in 1993 and was extended to include futures trading in 2004.

The VIX is used to determine market sentiment, but it doesn't predict which direction prices will head. Some call the VIX, "the fear index." The VIX is a way to gauge whether institutions might hedge their portfolios.

A normal reading in the index is between 20 and 30. A reading under 20 typically means that most investors aren't worried and that there are stable times on the market. A reading above 30 is associated with a large amount of volatility.

The Volatility Index is used as a contrary indicator. For example, when the VIX spikes to extremely high levels it means that the market could bottom out.

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