Mullooly Asset Show: Episode 42

Tom Mullooly: In Episode 42, we’re going to talk about the VIX, and it’s not Vicks Vapo-Rub. … Welcome to Episode 42 of the Mullooly Asset Show. I’m your     host, Tom Mullooly. In these episodes what we do is we get questions that we get either around our conference table during our morning meetings, or questions that we get from our clients, or from you our watchers. If you do have a question get in touch with us, don’t hesitate because you’re probably not the only person who’s thinking about stuff like these. The topic today was the VIX. What is the VIX Index? In fact, Tim, there was a two-part question that came in, do you want to read that?

Tim: I’ve been reading a lot of headlines about the VIX. What exactly is that?

Tom Mullooly: The question is, what is the VIX Index? How do we interpret this? What do we use it for? The VIX Index, if you’re driving to work and you’re listening to them talk about, “Hey, in the market the futures are doing this and the VIX is doing that,” understand that the VIX stands for the Volatility Index. How do we describe what a Volatility Index is? It’s not … I think the best way is to say what it’s not. It’s not an indicator that’s going to tell you that the market is going to go up or down over the next couple of days or hours, or months, it’s nothing like that. All it does is what the name implies, the Volatility Index. It’s going to tell you if the market’s going to be volatile or if it’s not going to be volatile.

The Volatility Index was created back in 1993. It originally started out with a … They were measuring the risk of volatility in the S&P 100. 10 years later, in 2004, they started trading the VIX Index based on the S&P 500, the 500 largest companies in the United States. The VIX has become more and more in vogue, if you want to call that, the last 10 years because short term traders want to know, is there going to be volatility in the market? What kind of indicator should we use this for?

The funny thing is, the actual interpretation of the VIX is that it’s supposed to give you a guide as to what the volatility is going to be over the next 30 days; not over the last 30 days, but over the next 30 days. Not over the next six months, next year, just 30 days. If 30 days isn’t the beginning and end of your investment lifecycle, don’t worry about it. Don’t get hung up that the VIX is high or low. The Volatility Index is really a measure of put buying, when you buy puts, or when you’re in the market and you want to protect the investment that you have because you’re afraid that the market is going to fall, you want to protect your investment you’re going to buy puts.

What the VIX does is it gives us … It’s a put buying ratio. As more people buy puts to try and protect or bet that there’s going to be a decline in the market, as we see put buying increasing, the VIX is going to go up; it’s a ratio. When the VIX is going down, it means that there’s less put buying so there’s less fear in the market. A lot of times the VIX is called the fear index, that’s a good way to remember it. Tim, what’s the next question?

Tim: Is there any sort of action that needs to be taken based on the VIX moving up or down?

Tom Mullooly: The question is, should we take action based on the VIX going up or down? It wasn’t all that long ago that the VIX was trading at 25 and 30 and today as we’re recording this, the VIX is hanging around 10. Also keep in mind that you can get a VIX on, a Volatility Index on the S&P 500, on the Nasdaq, on the Russell 2000, on the Dow Jones, just thirty stocks, so you have to be pretty specific about which VIX index you’re talking about. You can buy short term VIX investments, they shouldn’t even be called investments; short term, intermediate, long term, so you can be right in terms of how much volatility is coming into the market and still get your investment wrong because you bought the wrong one. You have to be super careful with these stuff, and it’s definitely for traders only.

What kind of action should you take based on the VIX moving up or down? The one thing that I’ll caution people to is … In 2008 we saw the VIX trading at 40, that was pretty high. We actually saw bigger spikes but for a long period of time we saw … During these volatile periods, we saw the VIX trading much, much higher than where it is now. Don’t get hung up on the number, it’s a relative index. Right now the VIX is hanging around 10. If it were to move up to 16 or 17, understand that’s a 60% or 70% increase from where it is now, so the VIX is always going to be relative.

If a month ago it was low and now it’s a little higher, that’s really going to be the tale of the tape so to speak, where we are with volatility. Remember, it’s volatility. It’s not necessarily the direction of the market. We can have years where the market can go up 25%, 30%, 35%, that’s a very volatile year, but it’s all volatility in one direction; up. We can also have the opposite where the market goes down 20%, 25%, a lot of volatility all in one direction. Don’t worry about volatility if you’re going to be a long term investor in the market.

That’s all we’ve got for you today. That’s plenty to talk about with the VIX. If you’ve got questions like that though, these are really good topics. People want to talk about them, they want to know more, get in touch with us. You can call us at (732) 223-9000, or you
can find us on the web at mullooly.net. Thanks for watching. Remember to click that subscribe button if you’re watching on YouTube. We’ll see you on the next one.

PS – Take a look at this Wall Street Journal article about the VIX as well! (PAYWALL)

Now Go Talk About It!