4 VIX Trading Strategies – Understanding the VIX Index and Its Functionality

An article about VIX trading strategies and explaining: what is the VIX and how does it work?

The VIX is a fear index and shows the price you need to pay to get insurance in the stock market. In this article, we explain what the VIX is, how it works, whether or not it can be useful for traders, and we end the article by backtesting some VIX trading strategies. VIX is a useful tool for traders and can help you build good mean revertive strategies in stocks.

(We have made potential trading strategies based on volatility – volatility trading strategies. Please check out our strategy bundles.)

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

In the short-term, fear and greed is a major driver of the swings in the stock market. The quote above is from Benjamin Graham’s The Intelligent Investor, and we believe Graham is spot on. Morgan Housel argues that the study of finance is in practice a study of how people behave with money. This means greed and fear are some of the main determinants in the short run.

How do we measure greed and fear? It turns out the options market has a component in its pricing that is called implied volatility. The Black and Scholes formula, widely used in determining the price of options, has only one unknown component: the implied volatility.

Luckily, we can construct an index, even a futures contract, based on the volatility in the option premiums. It’s called the VIX. This is a very handy tool to measure risk and make VIX trading strategies.