The Volatility Index (VIX) & the S&P 100 (OEX)

The Volatility Index (known as the VIX) measures the implied volatility in the prices of a basket of options on the S&P 100 index (OEX).  The S&P 100 itself contains the largest 100 stocks in the S&P 500 that have options traded on them.  

The VIX covers a relatively narrow group stocks, but those stocks are among the largest companies traded in the United States.  Quotes on the VIX are available in real time throughout the day on many services.  You'll find some sources further down on this page.  

What Does it do?

The VIX measures implied volatility in S&P 100 options.  It can be used as a tool for measuring investor fear.  High readings (above 50) mark periods of maximum fear and have marked important market bottoms.  Low readings (below 20), while not as accurate and timely as high readings, illustrate investor complacency and usually point to market tops.

The VIX in Action

The five-year charts below show the VIX on top and the S&P 100 below it.  The three times during the period covered that the VIX reached the 50 area, in October of 1998, in September of 2001, and in July of 2002, were all followed by powerful rallies in the S&P 100 Index (and in all the other major indexes like the Dow Jones Industrials, the S&P 500, and the Nasdaq Composite). 

The October 1998 Market Bottom (The Long-Term Capital Management Crisis) 

The actual high made by the VIX on October 8, 1998, near the left side of the top chart, was 60.63.  (Please note that the charts show only the daily closing prices and not intraday levels).  The VIX closed at 48.56 that day.  The S&P 100 traded as low as 454.93, but bounced back to finish at 471.84.  The S&P 100 climbed to 590.82 by November 27 of 1998.  It recorded a 25.2 percent gain in just more than a month and a half.  As the second chart indicates, the S&P 100 eventually rallied to above 800 by the first quarter of 2000.

The September 2001 Market Bottom (The September 11 Terrorist Attacks)

The VIX reached 57.31 on September 21, 2001, before backing off to close at 47.21.  The S&P 100 dipped to 480.07 that day, but closed at 491.70.  Less than two months later, on November 19, the S&P 100 settled at 595.07.  The 21-percent gain in the midst of one of history's worst bear markets was certainly welcomed by exhausted traders!   

The July 2002 Market Bottom (The Insider Trading and Accounting Scandals)

The bear was far from being finished with his dirty work as the markets plunged again during the summer of 2002.  The VIX shot up to 56.74 on the morning of July 24, 2002, as panicked investors sold stocks that they must have thought were going to zero.  As the market rebounded later in the day, the VIX pulled back to close at 45.29.  The S&P 100 plunged to 384.96, but came back to close at 419.98 that day.  On August 22, less than a month later, it settled at 485.95.  That works out to a 15.7 percent gain on a closing basis and a 26.2 percent climb from the July 24 intraday bottom.

The VIX Helps To Spot Lows During Both Bull And Bear Markets

As can be seen on the charts above, the VIX pinpointed tradable market bottoms during the height of the late 1990s super bull market and also on two occasions during the worst bear market since the Great Depression.  Like other indicators that have been accurate for periods of time, we think that the VIX can be used as a helpful tool for market timing.  

To buy stocks or go long the market when it reaches levels above 50 takes come courage.  If you go back and review the headlines during the three periods discussed above, you will get the idea that the investment world as you knew it, was about to come to an end.  

Using S&P 100 Options to Trade Extreme Levels in the VIX

One way to profit when the market reaches these extreme levels (and we expect more of them to be seen in coming years) is to trade it with options in the S&P 100 Index, commonly known as the OEX.  Since the VIX itself measures option volatility in the OEX, it is probably the best index to use for trades.  If the timing is right, call options that cost as little as $200 or $300 each, can quickly double or triple in price.  If the entry point is not right, the most at risk is the amount paid to purchase the call option.   

On the evening of July 23, 2002, after the major market indexes had closed lower four times in a row and the VIX had reached buy territory, Stricknet's nightly options report made the following pick:

For investments, we are looking to buy calls on the S&P 100 Index (OEX) any time the major averages have a huge intraday selloff this week. That would work out to 500 plus points on the Dow or 75 points or more on the Nasdaq. We would be looking to use whichever OEX August calls that could be picked up for 2.00 points or less. This trade would attempt to capture a two or three-day rebound from such a deep selloff.

If that were to occur, depending on how price and volume patterns are going, we'd then look to purchase some inexpensive August OEX puts. The thought here is that this rally would fail like all others this year have. With the possibility of a lot of fireworks between now and August 14, short-term trades using calls and puts in the volatile OEX could be among the market's best opportunities. Today, the VIX, an indicator that measures fear and complacency among OEX option players, rose by 2.25 points to 50.48. It was the first time that the contrarian sentiment gauge has ever settled above 50.

The market cooperated by plunging on the morning of July 24, but not by as much as described in the newsletter.  When the VIX reached 57, early in the day, we picked up some inexpensive OEX August call options as described in the excerpt from the options report sent to subscribers on the evening of July 24, 2002: 

When we saw world markets trading sharply lower and the VIX pop up to near 57 this morning we thought that things had gone too far and we decided to nibble on the long side with some S&P 100 Index (OEX) options. We bought some August 450 calls (OXBHJ) at 2.30 each. They settled with a bid of 5.00 as the OEX rallied back from an 11-point deficit to close 23.23 points higher at 419.18. 

On July 30, 2002, those August OEX calls, purchased for $230 each, were sold for almost $1,000 each.  On that day, OEX September 500 calls were purchased for $320 each.  On August 21, 2002, some of those September calls were sold for $700 each.  

Live Charts of the OEX

You can see live real-time charts of the OEX at Lycos Finance (formerly quote.com).  Type in the symbol $OEX.X, click on "LiveChart" in the dropdown box immediately to the right, then click the "Submit" button.  This is a free site and you can create 11 different chart views with bars ranging from one minute, which covers the very short term, to one year, which goes back to the beginning of their database.

 Quotes for the OEX  

Options quotes for the OEX can be found at Yahoo Finance under the ticker symbol ^OEX.  You can also pull up quotes at the Chicago Board Options Exchange site under the ticker symbol OEX.

Invitation to Try Out the Service

You can find out which OEX options are being used now by subscribing to Stricknet's service at http://www.stricknet.com/main/register.htm.  There is a no-obligation 7-day trial period during which you will receive the nightly options report by email as well as a nightly covered call report that has been published every market day since the fall of 1997.  Members also have unlimited access to the Stricknet Covered Call Calculator and the Naked Put Calculator.  

Free Bonus

As a bonus for trying the service, you also get Fred Strickland's ebook entitled "Trading Options -- Developing A Plan."  This 106-page ebook, written by the successful individual option investor and founder of this site, is yours to keep whether or not you continue your membership beyond the 7-day trial period.  You can find out more about Mr. Strickland and the book on our sister site GrayMetalBox.com.