To gauge the prevailing fear and dread among stock market investors, traders look to the VIX, formally known as the Chicago Board Options Exchange Market Volatility Index. An index of options prices that rises -- along with options values -- whenever market volatility is high, the VIX itself is open to trading, either for speculation or hedging. Exchange-traded funds make the play a fairly easy one even for novice investors.
Open a trading account with a broker or via an online platform. Fund the account with risk capital -- money you can afford to lose. Investors who want to trade the market indexes, such as the S&P 500 or the VIX, have several options, including active exchange-traded notes, or ETNs. Your broker may require a review of your credit and trading history before you can speculate in futures or options contracts.Step 2
Research the ETNs tied to the VIX index. These include the iPath S&P 500 VIX Short-Term Futures (VXX), iPath S&P 500 VIX Mid-Term Futures (VXZ) and VelocityShares Daily 2X VIX Short-Term (TVIX). As the markets fall, the VIX index tends to rise; thus the ETNs make a good hedge against a market crash. The ETNs, as well as exchange-traded funds on the VIX, hold futures contracts on the VIX options, which trade on their own.Step 3
Research puts and calls on the VIX index, listed on the Chicago Board Options Exchange. A put is a contract to sell, with the expectation that the index will fall; a call is a contract to buy, in the hopes the index will rise. You need an option-approved trading account to trade these options, which are not priced based on the "spot" or current value of the VIX index. They are based on expected performance of the S&P over the next 30 days, as indicated by S&P index options that expire in the current or following month. For this reason, the VIX options usually don't swing as much in price as the spot value of the VIX index, which you can't trade directly.
- The VIX can be useful as disaster insurance, as the index generally moves in opposition to the S&P 500. If you are holding stocks but fearing a downturn, you can protect against losses by "going long" -- buying the VIX index through ETNs, ETFs or call options contracts. This involves a lot less risk than shorting indexes or individual stocks.
- The exchange-traded funds and notes based on the VIX tend to lose their intrinsic value quickly over a short period. Buying and holding these instruments, therefore, is not likely to be a successful strategy. For longer-term plays on market volatility, consider put and call options on the S&P 500 index that have several months remaining until contracts expire.