The VIX volatility index is a gauge of the fear and greed that market participants are experiencing and can be used as a tool to help guide binary options traders as it relates to the S&P 500 index. The VIX is a measure of the implied volatility of the at the money calls and puts of the S&P 500 index, and reflect the level of premium that needs to be paid to purchase at the money options.
Implied volatility is an estimate of the distance the S&P 500 index will move over a certain period on an annualized basis. For example, a VIX reading of 13.98% means that market participants believe that over the next 30 day period, the S&P 500 index will move 13.98% when annualized, or 1.17% over the next 30 days.
The VIX index generally moves higher when fear is prevalent, as traders will pay a higher premium for protection against an adverse move in the S&P 500 index. The index will usually decline when complacency is on the rise, as traders believe the large cap index will remain subdued.
The correlation, which is how much the VIX and the S&P 500 move in tandem is generally negative, which means as the VIX climbs the S&P 500 generally falls. An investor can use the negative correlation to potentially predict movements in the large cap index. As fear rises, and the VIX climbs, there is a higher chance that the S&P 500 will make a downward movement. The VIX can also be used as a contrarian indicator. When the VIX is low for a while, and complacency sets in, traders are not prepared for a shock, and therefore could experience a wild ride.
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