Grasping Market Trends: Taiwan Fear Index and Volatility Index Investment Guide

What Exactly Is the Fear Index Measuring?

When mentioning the VIX Fear Index, many investors’ first reaction is that it serves as an early warning signal for market crises. In fact, VIX (Volatility Index) is a quantitative measure of the expected volatility of the S&P 500 index over the next 30 trading days, created and maintained by the Chicago Board Options Exchange (CBOE) in 1993, hence also known as the CBOE Volatility Index.

This indicator is called the “Fear Index” not because it can predict market declines, but because it can keenly reflect investors’ expectations of market risk. When VIX values rise, it indicates that market participants anticipate increased volatility; when VIX declines, it suggests market sentiment is calming.

Looking at the numerical range, 0-15 generally indicates a stable market, 15-20 is considered normal, 20-25 reflects emerging concerns, 25-30 indicates increased volatility, and above 30 often accompanies market panic.

How Is VIX Calculated? What’s the Underlying Logic?

VIX calculation is not a simple historical volatility statistic but is based on a weighted average of the implied volatility from the S&P 500 options market. The process involves: first collecting data on call and put options with various expiration dates and strike prices; then deriving implied volatility from these option prices; finally, integrating these data through a weighted average to produce the VIX index.

VIX is expressed as an annualized percentage and follows a normal distribution probability. For example, if VIX is 15, it implies the market expects an annual volatility of 15%, which translates to a standard deviation of about 4.33% over 30 days—that is, there is a 68% probability that the S&P 500’s fluctuation in the next month will stay within ±4.33%.

The advantage of this calculation method is that VIX reflects market expectations of future volatility, not historical facts, giving it a forward-looking characteristic.

VIX Performance During Market Crises

Historical data clearly records the impact of major financial events on VIX:

• 1997 Asian Financial Crisis
• 2001 9/11 Terror Attacks
• 2008 Global Financial Crisis (VIX peaked near 80)
• 2010 European Debt Crisis
• 2018-2019 US-China Trade Tensions
• 2020 COVID-19 Pandemic outbreak

Each major crisis was accompanied by a sharp surge in VIX.

Among these, during the COVID-19 pandemic in 2020, market panic reached its peak. In Taiwan, the Taiwan VIX touched a historical high of 57 on March 23, 2020, when the Taiwan stock index plunged 344 points to 8,900, and global financial markets were in extreme turmoil.

An interesting statistical pattern is that VIX tends to rise before US presidential elections. Studies show that 60 days before the election and on election day, VIX is usually at higher levels, reflecting investors’ hedging needs against political uncertainty. For example, before the 2008 election, VIX nearly doubled two months prior; during the 2020 election, VIX reached a high of 41.16 on October 29 but quickly fell after the results were announced.

The Interaction Between VIX and Stock Market Indices

VIX and the S&P 500 exhibit a typical inverse relationship: when the S&P 500 declines or market volatility rises, VIX usually increases; and vice versa. However, this inverse relationship is not absolute.

In reality, the relationship between the Dow Jones Industrial Average, Nasdaq, and VIX is more complex. While the volatility of these indices does influence VIX levels, VIX mainly tracks the volatility of the S&P 500, and its predictive power for other indices is limited. Sometimes, the market may decline without a significant rise in VIX, because once uncertainty is resolved, even a slight market dip can lead to a contraction in volatility.

Taiwanese Investors’ Choice: Taiwan VIX

The Taiwan Futures Exchange launched Taiwan VIX (TAIWAN VIX) in 2006, based on Taiwan index options, calculated according to the CBOE formula. Due to Taiwan’s export-oriented economy and strong linkage with global markets, Taiwan VIX often reflects influences from international economic and political factors.

In recent years, Taiwan VIX has broken above 30 three times. Besides the COVID-19 peak in March 2020, the escalation of local COVID-19 cases in May 2021 caused Taiwan stocks to plunge, with Taiwan VIX approaching 40; earlier, in February 2018, a sharp decline in US stocks triggered global panic, and Taiwan VIX also exceeded 30. Since 2023, as markets stabilized, Taiwan VIX mostly fluctuates between 10 and 20.

From Theory to Practice: How to Use VIX for Investment Guidance?

Identifying Market Turning Points

VIX reversals often signal key market turning points. Research indicates that when VIX surges rapidly and stocks are in a downtrend, it often means the bottom is near—potential buying opportunities. Conversely, when VIX rebounds from lows while the market is still rising, it may foreshadow a trend reversal.

Note that VIX tends to generate buy signals synchronously, but sell signals tend to lag. Investors should adjust strategies accordingly.

Dynamic Asset Allocation

VIX levels directly guide position management. When VIX is low (0-15), markets are relatively stable, and investors might consider increasing equity exposure or buying on dips. When VIX rises above 20, it’s prudent to reduce risk exposure, consider increasing allocations to bonds, gold, or holding cash for opportunities.

Precise Hedging Tools Selection

VIX futures, options, and other derivatives can serve as effective hedging tools. When investors expect increased market volatility, they can buy VIX-related products to protect long-term stock holdings. However, such hedging is not perfect—high VIX does not necessarily mean a bear market; it only reflects volatility expectations, not directional forecasts.

Practical Tools for Trading VIX

VIX Futures and Options

Since CBOE launched VIX futures in 2004 and VIX options in 2006, investors can directly participate in volatility trading through these derivatives. VIX futures allow delivery at a specified price on a future date, while VIX options offer more flexible risk management.

ETFs and ETN Products

For retail investors, VIX-related ETFs or ETNs are the most convenient ways to participate. Major products include:

• VIXY (ProShares Short-Term VIX Strategy ETF): good liquidity, tracks short-term VIX futures
• UVXY (ProShares Ultra VIX Short-Term Futures ETF): 1.5x leveraged, suitable for aggressive traders expecting rising volatility
• VXX (Barclays VIX Short-Term Futures ETN): classic volatility investment tool
• SVXY (ProShares Short VIX Short-Term Futures ETF): inverse product, used during volatility declines

It’s important to note that these products have an inherent roll decay issue. Due to the expiration of VIX futures contracts, continuous rolling during low volatility periods causes products like VXX, UVXY, VIXY to gradually lose value.

Current Market Environment and VIX Interpretation

Entering 2024, despite concerns over Federal Reserve policies, geopolitical risks, and corporate earnings, VIX remains relatively moderate. Over the past year, VIX mostly fluctuates between 12-20, well below its historical average of 18.5 since 1993.

Statistically, the standard deviation of the S&P 500’s daily returns over the past 100 days is only 0.7%, about 30% lower than the 1% average over the past 14 years. This suggests that market volatility is at a historic low, seemingly signaling a “bullish and steady” market to investors.

Deep Reflection: Limitations and Proper Use of VIX

VIX is not an absolute market prediction tool, and this must be remembered. It measures volatility expectations, not directional forecasts—markets can continue to decline even as volatility drops, or rise amid increasing volatility.

Furthermore, VIX mainly reflects the expected volatility of the S&P 500, with inherent limitations in predicting Dow Jones and Nasdaq movements. Simple application of VIX to these indices is not advisable.

The correct approach is to use VIX as part of a multi-dimensional risk assessment framework, combining fundamental analysis, technical signals, and market liquidity conditions to make comprehensive investment decisions. Monitoring VIX futures and options trading activity can also provide a more nuanced understanding of market sentiment.

For those interested in volatility trading, it’s crucial to assess personal risk tolerance, fully understand product characteristics (especially ETN credit risks and roll decay), and avoid misusing hedging tools as directional speculation.