Fear: The Index

Feb 12, 2018
Originally published on March 1, 2018 3:21 pm

There is this thing called the VIX. Some people call it the fear gauge. It was invented to measure people's expectations about how much the stock market is going to bounce around.

At some point, the VIX went from measuring expectations about the stock market. To being something people bet on.

Then, last week, when the market plunged, the role of the VIX may have gotten even larger: This thing that was invented to measure the stock market may have started driving the market itself.

On today's show, Tracy Alloway of Bloomberg News tells us the story of the VIX.

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There's this thing that people call the fear gauge. It was invented to measure people's expectations about how much the stock market is going to bounce around. It's called the VIX.


And at some point, the VIX went from measuring expectations about the stock market to being something that people bet on.

GARCIA: And then last week, when the market plunged, the role of the VIX may have gotten even bigger. So this thing that was invented to measure the stock market, it may have actually started driving the market itself. I'm Cardiff Garcia.

VANEK SMITH: And I'm Stacey Vanek Smith. This is THE INDICATOR, Planet Money's quick take on the news. Today on the show, how the VIX went from being a measuring stick to something that people bet on to maybe even changing the market it's supposed to be measuring.


VANEK SMITH: The fear gauge. I feel like we should have organ music here...

GARCIA: Organ music.

VANEK SMITH: ...Right? (Imitating organ music). The VIX.


VANEK SMITH: I feel like the definition makes it sound less scary. But it measures volatility in the stock market. That is what the VIX does. Specifically, it measures how wildly, how much investors think the stock market is going to swing either up or down in the next month.

GARCIA: And for anything having to do with the VIX I've got an old friend I like to call because it's kind of her specialty. Her name's Tracy Alloway. She's an editor at Bloomberg. And she's super insightful on this topic.

TRACY ALLOWAY: I have been a long, longtime follower of what we call the volatility complex.

GARCIA: It's a whole complex?

ALLOWAY: Oh, yeah.

VANEK SMITH: (Laughter).

ALLOWAY: It's definitely a complex.

GARCIA: It's definitely a complex, and how the VIX is calculated is itself complex. Sorry.

VANEK SMITH: That's - that's amazing. It's a complex complex.

GARCIA: It is indeed. But what you need to know is that first, the VIX is based on derivatives that let you bet on the performance of the stock market over the next 30 days, and second, it's a number. So a normal VIX level is about 20. That's its long-term average. So roughly speaking, a VIX lower than 20 signals a calm market, a placid market. Higher than 20, that means the market is choppy.

VANEK SMITH: And there's this really interesting 10-year story of the VIX. It goes back to the financial crisis of 2008 when, not surprisingly, the VIX went crazy. It quadrupled and hit 80 during the very worst of it. But since then, Tracy says, as the economy's recovered, year after year, the VIX fell and fell and fell as the stock market rose.

ALLOWAY: So, yes, the market has been moving steadily up for a long time. But it's not like you wake up every day and the S&P 500 is up 3 or 4 percent, right? It's a...


ALLOWAY: ...Slow grind higher. And meanwhile, when we do get falls - and those have been extraordinarily rare - they're not at all close to what we used to get before the financial crisis.

VANEK SMITH: And the markets kept this spooky calmness even through the turbulence of the 2016 presidential election here in the United States and the rise of populism here and all over the world. Until two weeks ago, the VIX had spent a year hovering near its lowest point ever.

GARCIA: Now, to this point we've been talking about the VIX as a measure. But remember; the whole point of this story is how the VIX went from being a measure to being something people bet on.

ALLOWAY: They say, hey, I know the market's going to be fairly stable. We might be getting this slow grind higher in the equity market. But I want more than that, and therefore I'm going to make this bet on the market staying fairly quiet.

GARCIA: And what Tracy is saying is that people started betting on the VIX itself. In other words, people started making bets on the bets that other people were making about the stock market.

VANEK SMITH: Bets on bets?

GARCIA: Bets on bets on bets.

VANEK SMITH: Bets on bets on bets?

GARCIA: And down and down the whirlpool we go.

VANEK SMITH: This does not seem like it's going to end well.

ALLOWAY: Oh, yeah, this has been a huge, huge money-spinner for a bunch of people in recent years. And I'm talking retail investors right up to the biggest fund managers that we have.

VANEK SMITH: When Tracy says retail investors, she means just anybody. Banks created these ways for normal people to bet on the VIX. There were ways to bet that the VIX would go up and ways to bet that it would go down. And those bets that the VIX would go down became really popular because the VIX just kept going down.

GARCIA: Until a week and a half ago, Friday, February 2. The stock market started to fall and the VIX started to rise. And last Monday and Tuesday, it got extreme. The stock market fell even more. And the VIX, which had been hovering just above 10, shot up all the way to 50.3 - which, by the way, is today's indicator - 50.3.

VANEK SMITH: And when the VIX shot up, the people who had bet against it got clobbered. One financial product - it was called the XIV, which is VIX backwards - lost so much that it got wiped out. And XIV was really popular. It even had its own Reddit page.

ALLOWAY: Yeah. And I was watching it on Monday morning as these products were beginning to blow up. And some of the stories, some of the comments on there were just amazing. So, you know, one guy said he just lost his $7,000 deposit that he was saving up to buy a house. And someone asked him, well, why in the world did you put it on this XIV product? And he just said it seemed like a good idea at the time. Those are the kind of stories that you're hearing.

GARCIA: And some big money investors, hedge funds, insurance companies, they also lost money from their own strategies for betting against the VIX. Here's how. A lot of them had this strategy where when the VIX was low, they could own a lot of stocks. But when the VIX went up, under the rules that they'd created for this strategy, they had to start selling stocks.

VANEK SMITH: And that might have created this feedback loop. Selling stocks made the stocks go down and the VIX go up, which may have led to more people selling stocks, which would have made the stock market go even lower.

GARCIA: Look; there's no way to know why the stock market did what it did last week or, frankly, ever. But this story is pretty compelling. It's consistent with the facts. And it's not crazy to think that the VIX amplified last week's fall in the stock market. In other words, the VIX may have wound up affecting that thing that it was supposed to be quietly measuring.

VANEK SMITH: So, Cardiff, would you say that there is nothing to fear but the fear gauge itself?


VANEK SMITH: (Laughter).

GARCIA: But I like that you said it. I think there's a lot of things to fear, including the fear gauge.