The One Minute Millionaire Diamond Mine
 The Wealth Factor: Stock Market Strategies
 Knowing & Loving the VIX
 By Dr. Stephen Cooper

This week’s stock market article may appeal to the nerdier among us. But it need not be discounted out of hand by the novices. As you’ll see in a moment, the interpretation of this interesting chart indicator is very simple yet important.

The Volatility Index or “VIX” is an indicator that measures the expectations of near-term volatility as shown by the S&P 500 index option premiums. The VIX was introduced in 1993 and is now considered by many to be an excellent indicator of both market volatility and investor sentiment.

The VIX can be thought of as a "Fear gauge" as it reacts to market volatility which is often spurred by fears, uncertainty and turmoil.

The fundamental use of VIX is to consider expected market volatility over the coming 30 calendar days. As of September 2003, the VIX is calculated with a new formula that considers the average of weighted prices of both out-of-the-money calls and puts, and Standard and Poor’s 500 options. Formerly, the VIX was calculated using the Black Scholes model of option pricing and the OEX.

The Volatility Index (VIX) is a measure of implied or expected future volatility rather than historical or statistical volatility. As the VIX rises, a greater sense of investor fear or uncertainty is implied. When the VIX is low, a relative state of investor complacency is indicated. So, periods of market turmoil will show an increased VIX; primarily because the demand for OEX put options as hedges is increased.

When comparing a VIX chart to an S&P Index chart, an inverse relationship of the two traces will be noted. Because of this, the VIX can be employed as a contrarian indicator in a similar fashion to oscillating indicators such as stochastics or Williams %R. You’ll see what I mean in the chart below.

What we are doing here is looking at the options market as an indicator as to what the stock market is likely to do. With the increase in use of options, over the past decade in particular, we find that the stock and options markets are becoming increasingly intertwined.

When a divergence between the VIX and the direction of the S&P 500 index is seen, we expect a change in the S&P direction to soon arrive. This counterbalancing relationship is not particularly helpful in short-term trading but can offer excellent insight in overall market bias, whether Bullish or Bearish.


As a trader, teacher, author and lecturer Dr. Stephen Cooper has guided thousands of students to greater success in trading stocks and options. His site, is an excellent resource for traders of all levels. A free newsletter is available by going to Over the past five years Dr. Cooper has conducted live teleconference courses covering personal financial basics, stock screening, technical analysis and practical trading. He has authored The Online Option Trader, Windows to Wealth, and The Truth About Money. With over 18 years of experience Dr. Cooper is recognized for his successful techniques, his clear and systematic teaching style, and technical expertise.