"The S&P 500 could break through the 3,600-point level in the near term as companies cut their earnings forecasts for 2023," - said David Kostin, chief equity strategist at Goldman Sachs. This would mean a decline in the main S&P 500 index of more than 8%. How could someone take advantage of the potential increase in volatility?
Fear Index
The instrument that assesses the volatility for the S&P 500 (US500) index over the next 30 days is the CBOE Volatility Index (VIX). Its value is determined by the pricing of options on this index. However, let us remind ourselves of the possible options. There are derivatives that give buyers the option to buy call (or in the case of put options, to sell) at a given price in the future of the underlying instrument. Importantly, call and put option quotes are priced independently. Because historically the index has reached its highest levels at times of major falls, it is commonly referred to as the fear index.
Source: Conotoxia MT5, VIX, Weekly
The fear index peaked during the 2008 real estate crisis. - around 60 points and during the 2020 pandemic crisis. - around 80 points. Currently, its value is around annual lows, at around 20 points.
Theoretically, the value of the fear index could increase with sudden movements (regardless of direction), and with slow changes the index could reach lower values. In line with this, the decline of the S&P 500 index by more than 17% since the beginning of the year has not triggered sizable increases in the fear index.
Source: Conotoxia MT5, US500, Weekly
ETFs on the VIX index
A long-term alternative to investing in the Fear index are ETFs that replicate its movements. It seems that special caution should be exercised in this type of investment due to their complex structure and built-in leverage. The first fund is the Ultra VIX Short-Term Futures ETF (UVXY), which gives exposure to the index with average leverage times 2. It consists of short-term contracts on the VIX index quotes. If we would like to trade in the opposite direction, ProShares offers the opportunity to invest in the Short VIX Short-Term Futures ETF (SVXY). It consists of the same contracts as its predecessor only with opposite positions.
Source: Conotoxia, MT5, UVXY, Weekly
What can we expect in the future on the VIX?
Forecasting changes in the fear index could be difficult and fraught with risk. However, specific events trigger specific market reactions. These include, for example, the publication of surprising data to which investors seem to pay particular attention. At present, these may include: employment figures in the non-farm sector, the Fed's interest rate decision or inflation indicators. The advantage of the fear index, however, seems to be that if there is volatility following the publication of data, we may not have to worry about its impact on the broad market, as the value of the index depends on the expected rate of change.
Grzegorz Dróżdż, Junior Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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