WATCHING THE VIX.

I Hate To Be Boring. One of the biggest sins a writer can commit is to be boring. I would almost rather be dead wrong than boring. As I contemplate this post, I can picture the eyes of many readers glazing over because they don't care about the VIX. Unfortunately, I think it is of sufficient importance that I can't afford not to give you the opportunity to know what it is and how it can affect your investments.

Definition: The VIX comes from a calculation by the Chicago Board of Options Exchange (CBOE). It is a measure of the implied volatility in the market place. A high number means the market is more volatile than normal while a low number means less. High numbers usually occur in falling markets while low numbers usually occur when the market is rising. As a rule, most investors consider the VIX as a measure of fear in the investment community. At high fear levels, option demand picks up as more folks try to hedge their bets. You can buy put options which give you a right to sell at a given price. If the price of the stock drops, your loss is limited to the strike price of the put minus the premium you paid when you purchased it. You can also sell a call against a stock you own in order to earn a premium to offset part of the loss should the price drop.

Implications. Some investors use the VIX as a means of predicting highs and lows in the market. An old rule says when the VIX exceeds 40, the market is nearing an oversold situation and a rebound can be expected. Conversely, when the VIX is below 20, the market is approaching an overbought situation and a correction is anticipated. Although I use this rule, I consider it just another data point and would encourage investors not to place too much credence in these numbers. For example, in the debacle of 2008, the VIX went right past 40 into the 80's. This level is unprecedented in all the years in which this number has been published. If you had been depending on a bottom in the 40's, you would have found that you had a considerable period of falling prices before a turnaround occurred.

Another implication is that option prices will be higher when the VIX is high and lower when the VIX is low. Although each security has its own volatility levels, a general rule is that you should be buying options when the volatility is low and selling when volatility is high. If you own a stock and are considering writing calls against it, you are better off doing this at periods of high volatility. At that point, call buyers are willing to pay higher premiums and you will make money if volatility drops and you will have more downside protection if the stock price drops. At times when the VIX is lower, you might consider buying options instead of the stock.

Understanding The VIX Can Give You An Edge. While this information can give you a bit of an edge over investors who ignore it, it will probably not make you wealthy. Other fundamental and technical data is necessary for sound investment decisions.

This is My 150th Post or Close To It. I have enjoyed writing this blog and interacting with my readers. While I still have topics in mind for future posts, I would invite my readers to suggest others. You can send me an e-mail or comment in the comment sections. I will post most comments as long as they are in good taste and not too hostile.