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‘Fear Index’ feels impact of Coronavirus

calendar 09/09/2020 - 11:38 UTC

The VIX, short for the CBOE Volatility Index, is used by investors around the world as a way to measure market risk, fears and stress—factors that may help them make investment decisions. Also known as the “Fear Index,” the VIX is closely linked to the S&P 500 index, considered the most accurate representation of the US stock market. Typically, when trouble is brewing and global markets fall, causing major indices to decrease, the VIX tends to rise, which often signifies volatility. And as the coronavirus pandemic has continued to cause major upheaval in the early part of 2020, the VIX responded accordingly, surging 350% between 16th February and 22nd March and hitting the highest levels since the 2008 financial crisis.

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Some investors saw it coming

2020 was already slated to be a pretty volatile year to begin with. Just take a look at what’s on the agenda: the US election and rapidly changing geopolitical climate, encompassing everything from the US/China Trade War to the repercussions of the short-lived oil war between Saudi Arabia and Russia, and with ongoing pandemic fears adding further uncertainty, any speculation that the VIX was headed for volatility in 2020 has certainly come to bear.

The 2020 US election

In the United States, the November election looms large as all eyes are on Donald Trump, whose approach to handling the crisis has received its share of both praise and criticism from democrats and republicans alike. While the media panned his slow response time, Trump moved fast in an attempt to soften the economic blow by suspending mortgage foreclosures, requesting cash payments to US citizens, and summoning the Defense Production Act that would force private businesses to produce high-demand supplies. All actions that prompted elected officials like progressive democratic representative Ilhan Omar to put aside politics, calling the response ‘incredible’ and appropriate for such a critical time. Many believe the strong economic gains achieved under the Trump administration is the incumbent president’s strongest argument for re-election, and Trump was also quick to initiate stimulus plans that led to the unprecedented American $2 trillion assistance program. But some analysts predict - should the US economy take more of a hit - it could potentially unravel any momentum Trump has going for him.

Meanwhile, the COVID-19 pandemic has shaken things up on the other side of the aisle. For much of 2020, with Joe Biden front and centre of ambitions to topple President Trump after securing the democratic nomination. However, questions about his health have beset the democratic candidate, with further scrutiny about who he would nominate as his running mate to potentially become the Vice President of the USA. Biden's campaign announced that he would pick a female running mate, narrowing the options and amplifying the scrutiny on existing candidates, while at the same time heightening speculation of the media and general public.

Oil Price War: Saudi Arabia vs. Russia

In early March, oil prices fell to a four-year low as Saudi Arabia sparked a price war against Russia, rattling stock markets all over the world. To update you, here’s the long and short of what happened. As the spread of the coronavirus caused factory shutdowns and diminished consumption, essentially lowering the demand for oil around the world, OPEC proposed cutting oil production to help mitigate market losses. Russia refused to accept the proposal, a move which sent oil prices down 10%. Saudi Arabia responded by lowering its April oil futures prices to between $6 and $8, which increased pressure on Russia.

With a stalemate at hand, President Trump stepped in with an attempt to broker his own deal. Speaking directly with Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman, he urged them to cut their respective domestic oil production by as much as 15 million barrels, thus driving oil prices back up. Once this news went public oil prices shot up almost 50%, but eventually fell as neither Russia nor Saudi Arabia made clear their agreement to the proposed terms. Eventually, with US intervention, OPEC - including Saudi Arabia - and Russia agreed to cuts in oil production, and the price has shown a slow steady climb since, with the threat of further volatility hanging over it.

But how does all this relate to the VIX?

Presidential elections, geopolitical events (e.g.: oil price wars) and—as we’ve learned over the past three months - global pandemics, can raise the pulse rate of stock markets, sending the VIX soaring. Added to this is the interesting fact that some investors have noticed a historical relationship between the VIX and the S&P 500 index, which has come up negative in only four elections since 1928.

Want to get more specific? Take the Russia/Saudi Arabia oil war. Almost immediately after Russia made its defiant move on 8th March, the S&P contracted by 7.6%, and the VIX—true to form—began a steady ascent, rising 45% over the next week alone.

In conclusion, while we can’t say the predictable behaviour of the VIX makes it a dependable trading instrument (because past performance is not an indicator of future performance), it’s still worth noting how this “fear index” is used by traders all over the world to gauge market sentiment and measure risk. The VIX is hovering around the performance set by the 2008 financial crisis, leading many to speculate what may happen next. With a major US election only months away, the Saudi/Russia price war still unfolding and the coronavirus pandemic adding further fuel to the fire of global market volatility, who knows what move the VIX may make next?

For traders of volatility, the performance of the VIX presents both risks and opportunities. At iFOREX, you can trade CFDs on price movements of the VIX, as well as on hundreds of other instruments including commodities, ETFs, crypto and foreign currencies. Sign up today and take advantage of free educational resources and 1-on-1 training with a coach.

The materials contained on this document should not in any way be construed, either explicitly or implicitly, directly or indirectly, as investment advice, recommendation or suggestion of an investment strategy with respect to a financial instrument, in any manner whatsoever. Any indication of past performance or simulated past performance included in this document is not a reliable indicator of future results. For the full disclaimer click here.