Introduction To VIX | Volatility Trading Strategies for Beginners | Quantra Course

Part of the course Volatility Trading Strategies for Beginners: https://quantra.quantinsti.com/course...

Welcome to this video on introduction to VIX. Sophie is an experienced trader and she's been in the market for quite a few years. She has observed that when unexpected events take place such as the US-China trade war the market declines sharply.
In fact, she has seen this quite a few times. For instance, in March 2020 when the covid-19 pandemic was declared, the S&P 500 index declined by more than 30%. When the Russia Ukraine conflict started, even then the market declined. Further, she observed that during these times the market prices fluctuate sharply.
This means that the volatility is relatively high during unexpected events. But over time the market sort of stabilizes, and the volatility goes down. Thus, Sophie knows that when an unexpected event takes place, the volatility increases sharply. But over time it goes down. She knows that the volatility is going to reduce and she can benefit from taking a short position on volatility, but how to trade volatility?
Maybe she can use options. But then Sophie knows about volatility. Whereas in options you have to factor in parameters such as delta, gamma, and theta, which affect the option’s price. So it would be quite difficult to only trade volatility through S&P500 index options.
If we have an index for trading in US stocks such as S&P500, why not have an index for trading volatility?
Don’t worry, Sophie. The VIX was created to trade volatility. It is created for those traders who know about volatility, and would like to trade based on the volatility alone. How to trade VIX?
VIX is a volatility index. You can trade in VIX using derivatives such as VIX futures or VIX ETFs. Thus, by buying and selling VIX futures or VIX ETFs, you are trading based on your view of S&P500 volatility only. The VIX graph is shown on the screen. As discussed before, you can see that during unexpected events, such as the US-China trade war, the VIX rose sharply. And then after a few months, it declined as well. Or we can say the volatility went down.
Similarly, during the covid-19 pandemic declaration, the VIX rose sharply and it touched the level of 80. And then it declined sharply as well. During the Russia Ukraine conflict, the VIX has started increasing. Thus, when you think that the volatility will increase, you can go long on the VIX derivatives. And when you think that the volatility will reduce, you can short VIX derivatives.
In this way, you can use your knowledge about the volatility and place your trades on VIX. Are there other ways to use VIX?
Let's say that Sophie has a portfolio of 20 stocks in the US. But if the market goes down her portfolio will decline. If you know that the VIX actually increases during unexpected events you could take a long position on the VIX derivatives to hedge your portfolio. Let's see how that can happen.
Here we have the S&P500 price graph and the VIX graph. You can see that when the S&P 500 declines during an unexpected event, the VIX actually rises. Thus, in a way you can say that the VIX is negatively correlated to the S&P 500 Index. But that may not always be the case.
However, a negative correlation is observed during market fall. So if you have a long-only portfolio that is declining, and you can see that the VIX is rising, you can go long on the VIX derivatives. In this way, you have hedged your portfolio from unexpected downfall.

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