As the S&P 500 is the default benchmark for performance, it makes
sense to gauge the collective investment community’s expectation of 30-day
volatility. Volatility calculations are constructed to be forward looking using
both puts and calls.
3 key "Investor Fear Gauges"
VIX S&P 500
Volatility Index (the most widely used measure of Market Risk). This product is optionable.
VXN Nasdaq 100 Volatility Index. This product is optionable.
VXD Dow Jones Industrial Average Volatility Index. Use this for tracking purposes, the product is not optionable.
Pay attention to the VIX, the core gauge of the broader market’s propensity to buy/sell 30-day IV; versus, blindly looking at just the
Put/Call ratio specific to the product you are trading.
Market makers on the floor respond to
the VIX, not any individual Put/Call ratio unique to a given product.
❑ VIX at 10–12 is in the low range, below 10 is extreme. Low VIX is an opportune time to be long low volatility spreads.
❑ VIX at 17–20 is is in the high range, above 30 is extreme. High VIX is an opportune time to be short high volatility spreads.
❑ VIX at 13–16 is in an indecisive volatility range. Possibly a time to wait for the VIX to return to its high/low range.
Historically, the VIX has repeatedly found support at 10 to reverse up. Some proponents argue that VIX at 15 is the floor - the “new 10”. The VIX historically ran up against resistance near 30 but broke through 30 with the financial crisis of October 2008.
The VIX above 30 has not really had one year’s worth of trading at the new ranges, since October 2008, to find newly adjusted ranges for what is High–Normal–Low. Previously, you had the bands of between 10-20 and 20-30; but the new trading bands will only make sense at year end 2009 as the VIX settles into new ranges.
To figure out if the VIX is having a a High, Normal or Low trading range for a specific day, take the Annualized Volatility of the front month options of the VIX and divide it by the square root of 256 (256 trading days are the norm, exchanges are closed on weekends and public holidays; so, price cannot change on these days) which is equal to 16, i.e. VIX front month Volatility/16, to work out the daily volatility of the VIX. Want more on how to use this daily volatility gauge to Theoretically Price spreads?
Other than using these broad market sentiment measures, pay attention to the sentiment measures specific to sectors (see Bullish Percent Indexes).