The creator of VIX is betting that nothing will happen in the markets.

One of Wall Street's most popular positions is betting that nothing will happen in the markets.

Every day, traders across the country place bets that volatility will continue to decrease as stocks continue to climb higher and higher. And for the most part, they've profited from those bets.

This summer, VIX reached an historic low of 9. Today, it's hovering around 12.

The idea of a volatility index comes from Gary Gastineau in the late '70s and at that point, there were no index options. What he proposed and created was this volatility index based upon the volatilities of high market value stocks, and so the idea had been around for a while.

If you were to own a house on the North Carolina coast or Florida coast and you hear the news of this hurricane coming, would you be willing to pay more for insurance? And the answer to that is presumably so. In normal times, you may not be willing to pay as much. But when you know an event like that has a strong probability of occurring, what you'll do is pay more for insurance.

What happens is people want to buy more insurance, and the insurers are willing to sell it, but not at the same price. What they'll do is escalate their price because they have to be hedged in terms of their exposure. So during these times, like the hurricanes, people are willing to pay extremely more for insurance.

The analogy is institutions or people may have a pension fund largely consisting of stocks, now what happens when they become frightened of a stock market crash? They can exit their position, but they can also buy index put options. Essentially those are the insurance policy. These put options provide you with insurance on your stock portfolio, so if the market dives, the value of these put options will go way up and you won't lose any money.

The reason it's called the investor fear gauge is simply because it's driven by the demand for S&P 500 index put options. If institutions become frightened by certain geopolitical risks, what they'll do is rush in and buy a bunch of index puts. When they buy those, the VIX level will go up because it's nothing more than a weighted average of the prices of those puts.

When you see VIX go up, you can know there are a bunch of people out there that are buying insurance on the stock market because they're anxious about something. When VIX goes down, it's just recognition that people aren't too worried. The average closing level is 19. If it's 11 now, that means people aren't particularly concerned. At the same time, its level was 9 a couple weeks ago, so there's clearly more anxiety now than there was a few weeks ago, but relative to it's entire history it's just not that big a deal.

Source: Business Insider

Junior Trader Stefan Panteleev

Original Post: The creator of Wall Street's 'fear gauge' says people don't understand it as well as they should

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