When most new traders think about investing in the financial markets, they think about buying instruments when the prices are low and selling them when the prices are high. But the financial markets do not always keep moving upward. Sometimes the prices drop, and there are times when they can keep swinging up and down. The traders present in the financial markets are often concerned regarding the volatility present in the market. This is more so when there are huge negative movements, as seen during the time of the credit crisis or the start of the pandemic. Searching for investments that may grow in value when the financial markets decline to some protection on the downside is obvious. This is why some traders have started observing the VIX ETFs. It is a volatility index created by the Chicago Board Options Exchange.
A trader cannot invest money in the VIX itself. The exchange-traded instruments that use VIX futures have a lot of risks that the traders should find out before purchasing. This means that the investors can go for VIX ETFs as an instrument of investment. This is based on their calculations regarding whether the financial markets will start seeing some major fluctuations in prices in the near future. But it is also crucial that the investors know that these VIX ETFs can also lose money in the long run. This is why these are only suitable for short-term traders executed by active investors.
The name given for the index is an abbreviation of the term volatility index. The calculation that is done to find out its value is complex. But the main aim is to find out how much volatility the investors can expect to see in the major indexes over a month. This is based on the costs of the options of the S&P 500 index. When the options traders predict that the financial markets will remain calm, the value of the VIX ETFs remains low. When traders think there will be huge fluctuations in the financial markets, the value of VIX ETFs starts to increase. The value of the VIX ETFs also increases when there are periods of huge turmoil in eh financial markets. During the technology bubble in the late 90s, the prices of VIX ETFs kept moving constantly higher as the markets approached their peak. The prices calmed down when the financial markets went through steady growth in the early 2000s. It again increased during the time of the credit crisis. Finally, the VIX ETFs saw a great increase when there was great volatility in the financial markets because of the global pandemic.
Due to this type of behavior, the index is also called the fear index. This is because the prices of VIX ETFs increase when the stakeholders present are worried about the conditions of the financial markets. The traders who experience the prices of VIX ETFs to have increased by a lot when the financial markets went down may be interested in investing in them as a safeguard during times of volatility in the markets.
The main issue when going for the futures contracts of this index is something called contango. This is when the prices of futures are seen to be higher than the current price. For example, suppose the index is at five today, and the future contracts are trading at six. In that case, the futures market is in a contango. But you may not understand why this is a major issue. Your main aim may be to have some portion of your financial portfolio invested in the futures of this index. Suppose the futures contracts are always costlier than the present level of the index. In that case, you have to shell out a premium each time you purchase futures. You are purchasing high and selling low. This erases the value of your investment in due course.
These instruments have not been created for individual investors. They have been developed for people that want to make tactical and short-term trades in the financial markets. Suppose you think that the fluctuations in the financial markets are going to increase, or you want to hedge a trade against the probable fluctuations. In that case, you can think about taking a short-term position in VIX ETFs. But investors in the financial markets for the long term should not consider them for their own portfolios. Over the long term, VIX ETFs lose value because the financial markets continue to climb slowly. But in the short term, they can get a lot of profits, more so when there are huge fluctuations in the market. VIX ETFs are quite volatile and move quickly based on the stakeholders' sentiments in the financial markets. It peaked significantly when the global pandemic started and began declining to its normal levels some months later. After that, the prices of VIX ETFs have seen several falls and increases.
The traders who can predict when there is going to be uncertainty in the financial markets can buy these instruments and earn a lot of money. But the fluctuations of the VIX ETFs could also mean that the traders buy at a high price before a sudden drop in its prices.
The VIX ETFs come in a lot of different forms. If you want to get exposure to the index for a short period, there are various VIX ETFs available. But you should also remember that these are highly risky instruments, and you should transact with them after knowing all the factors involved.