Is market panic imminent? How the VIX index becomes investors' "hedging radar"

When the stock market experiences a significant decline, many investors notice a rapidly rising number — it is the so-called “fear gauge” among global investors. This tool, known as the Volatility Index (VIX), not only signals shifts in market sentiment but also serves as a key for savvy investors to capture opportunities.

Warren Buffett’s famous investment adage “Be fearful when others are greedy, and greedy when others are fearful” still shines brightly in today’s financial markets. However, investors need a more precise tool to measure just how fearful the market truly is — and that is the mission of the VIX Fear Index.

What exactly does the VIX Fear Index measure?

The Volatility Index (VIX) was introduced by the Chicago Board Options Exchange (CBOE) in 1993. Its core function is to reflect market expectations of the S&P 500 index’s volatility over the next 30 trading days. Simply put, it measures not past volatility but the anticipated level of future volatility.

The operation principle of the VIX is not complicated — it is calculated based on the price fluctuations of S&P 500 options. When investors face market risks, they buy large amounts of put options for protection, which pushes up option prices and consequently raises the VIX index value. The opposite is also true.

Interpreting the value is crucial:

• 0-15 range: Market is relatively calm, investor sentiment is stable
• 15-20 range: Normal fluctuation range
• 20-25 range: Warnings of concern begin to appear
• 25-30 range: Volatility significantly increases
• Above 30: Market falls into a clear panic state

How is the VIX index calculated?

This process involves complex mathematical computations, but the core logic is straightforward. Calculators gather prices of S&P 500 options with different expiration dates and strike prices, then integrate these data through a weighted average method to derive the VIX value.

Interestingly, the VIX value is expressed as an annualized percentage. For example, if the VIX is 15, it indicates an expected annual volatility of 15%. Correspondingly, the standard deviation of volatility over the next 30 days is about 4.33%. According to statistical principles, this means there is an approximately 68% probability that the S&P 500’s price change over the next 30 days will be within ±4.33%.

Extreme moments in history: how has the VIX responded?

Looking back over the past thirty years, whenever major crises occurred, the VIX Fear Index surged dramatically:

• During the 1997 Asian Financial Crisis, the VIX spiked rapidly;
• After the 2001 US 9/11 attacks, market sentiment turned extremely pessimistic, and the VIX soared;
• During the 2008 global financial crisis, the VIX approached a historic high of nearly 80;
• Under the 2020 COVID-19 pandemic shock, the VIX again broke through 50;
• During the 2023 Taiwan pandemic escalation, the Taiwan Stock Index VIX approached 40.

These data clearly show that the VIX index acts like a sensitive nerve, detecting every bit of unease in the market.

The subtle relationship between VIX and US stock indices

Generally, when the S&P 500 declines or volatility increases, the VIX tends to rise — a negative correlation. But investors should understand that this relationship is not absolute.

Market trends are influenced by multiple factors, including economic data releases, policy changes, geopolitical events, and more. Sometimes, the market drops only slightly, yet the VIX does not show a significant increase; other times, the VIX remains high while stocks continue to rise. This reflects the complex interaction between sentiment and reality.

For indices like Nasdaq or Dow Jones, the relationship with VIX is even more indirect — changes in volatility push up the VIX, which in turn can alter investor psychology expectations and influence the performance of these indices.

Taiwan investors’ tool: Taiwan VIX (台指VIX)

The Taiwan Futures Exchange launched the Taiwan VIX in 2006, based on Taiwan index options, using the same calculation method as international standards. Due to Taiwan’s highly open economy, the performance of Taiwan stocks is strongly correlated with the US market and international financial conditions, so the Taiwan VIX often shows high correlation with external factors.

Recent data shows that during the most severe COVID-19 period in 2020, the Taiwan VIX reached a historic high of 57, when the Taiwan stock index plunged by 344 points. Since 2023, as the Taiwan stock steadily rebounded, the Taiwan VIX mostly remained in a mild range between 10 and 20.

Overview of VIX-related investment products

In 2004, CBOE launched VIX futures, and two years later introduced VIX options, making VIX a tradable financial instrument. Today, investors can participate in VIX investments through various means:

VIX futures contracts allow investors to buy or sell VIX at a specific price for future delivery, used for speculation or hedging market volatility.

VIX options contracts are similar to stock options, enabling buying or selling VIX futures at a set price within a certain period.

VIX exchange-traded funds (ETFs) are the most convenient way for retail investors. For Taiwanese investors, highly liquid ETFs or ETNs such as VXX, VIXY, UVXY are practical options, traded just like stocks.

Among these, VIXY is a short-term bullish ETF, UVXY offers 1.5x leverage, and VXX is an ETN issued by Barclays. Each product has its own features regarding leverage, holding period, and liquidity, so investors should choose according to their risk tolerance.

Note that futures have expiration dates, requiring continuous rollover. In environments where VIX remains low for long periods, frequent rollovers can erode the value of these products — a risk investors must be aware of.

How can investors interpret signals from the VIX Fear Index?

Capturing event shocks

VIX is highly sensitive to major events. Economic data releases, political upheavals, financial turmoil can all trigger sharp VIX movements. Savvy investors observe these patterns to gauge market reactions to risk events and adjust their positions accordingly.

Guiding strategic choices

When VIX is low (usually below 15), the market is relatively stable, and investors might consider aggressive buying strategies. When VIX is high (above 25), market risk is evidently increased, and reducing positions or increasing hedges may be prudent.

As a hedging reference

VIX derivatives can serve as hedging tools for portfolios. When expecting increased market volatility, allocating some funds to VIX futures or options can provide protection during stock declines.

Timing reversals

Research shows that when VIX surges rapidly while the US stock indices are falling, it often signals that the market bottom is near — a classic buy signal. Conversely, when VIX starts rising from low levels while stocks are still rising, it may indicate an impending reversal.

Be aware of lag effects

Interestingly, VIX tends to be a coincident indicator for buy signals but exhibits lagging behavior for sell signals — investors should exercise caution when selling.

Current state and outlook of the VIX Fear Index

Over the past year, the VIX has mostly fluctuated between 12 and 20, indicating relatively stable market sentiment. Despite concerns over Federal Reserve policies, geopolitical risks, and upcoming presidential elections, the VIX has not reflected significant anxiety.

Data shows that the standard deviation of daily returns of the S&P 500 over the past 100 days is only 0.7%, well below the average of about 30% since 2010; recent VIX levels are also far below the 18.5 average of 2014. This suggests the US stock market is in a relatively stable bull phase.

However, investors must understand a fundamental limitation: the VIX primarily reflects expectations of volatility, not the market direction. It quantifies sentiment, not foresight.

Final investor reminder

For stock investors, the VIX Fear Index is an essential foundational tool, but it is not an absolute predictor. Combining VIX with other technical indicators and fundamental analysis enables more rational decision-making in complex markets.

In practice, considering multiple factors, conducting comprehensive market analysis, and establishing a scientific risk management system are the true keys to successful investing. The VIX is just a mirror in your hand, helping you see market sentiment more clearly — but the ultimate victory depends on rational decisions.