Can you use the Vix to predict a stock market crash?

by , 28 September 2015

The Vix is a well-known measure of volatility of the stocks on the S&P 500. Many refer to it as the fear gauge.

During times of market turmoil, the index tends to rise in value.

So what exactly is the Vix? And can you use it to help you with your investing decisions?

Let's take a closer look…


What is the Vix?


The Vix reflects the volatility of S&P 500 Index options traded on the Chicago Board Options Exchange (CBOE).

This means the Vix doesn’t measure the volatility of the S&P 500 itself, it measures expected volatility that’s priced into near term options.

This may give you the impression that the Vix is forward looking and reflects what traders’ think about the outlook of the S&P 500.

And this leads many investors and traders to believe the Vix can help to predict a stock market crash or crisis.


Is the Vix useful?


You can look at data for the Vix going back to 1990. There is also the Vix’s predecessor, the VXO, which has data stemming back to 1986.

Looking at their long-term averages, they both come in at about 20. This comes from long periods of volatility and explosive spikes during panics, Cris Sholto Heaton in Money Week explains.

For example, the VXO soared to 170 during the 1987 crash. During the financial crisis, the Vix hit nearly 90 at one stage.

Whilst this reflects when crashes happened, importantly the index only spikes during the market sell off, not before. This means it’s not predictive in any way.

Whilst you can use the Vix to confirm that the current market is volatile or trading under ‘normal’ conditions, it has no predictive qualities and can’t forewarn you about what may lie ahead.

So there you have it. Why you can’t use the Vix to predict a stock market crash.

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Can you use the Vix to predict a stock market crash?
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