The CBOE Market Volatility Index: Contrarian Opportunities at the Extremes The CBOE Market Volatility index (VIX) was introduced in 1993 by the Chicago Board Options Exchange (CBOE) to measure the implied volatility of the U.S. equity market. The index is calculated in real-time using the Standard and Poor's 100 Index (OEX) options. The index is calculated by taking a weighted average of the implied volatilities of eight OEX calls and puts having an average time to maturity of 30 days. CBOE Volatility Index (VIX) - Trends Inversely, Reflecting the Crowd's Pessimism or Optimism When markets decline, the VIX index typically moves inversely (as seen in chart above), rising to reflect the increase in demand for puts. At BigTrends.com we use the VIX index as a contrarian indicator of market sentiment. Fear and greed will often take the market to extremes, and the VIX provides an accurate measure of these phenomena. The higher the VIX, the higher the fear, which, as market contrarians, we generally see as a buy signal. In the same respect, the lower the VIX, the lower the fear, which indicates a complacent market. A good measure of extremes in the index is found in the 21-day Bollinger Bands on the VIX. When the VIX index reaches an extreme by closing outside of these bands and then sees a close back into the band, you can expect that shift in the market is likely to occur. Markets tend to bottom due to a peak in fear (on a high VIX reading over the upper band), while tending to top after an extreme in greed is reached (on a low VIX reading under the lower band, like the one seen in the lower half of the chart above, as optimism grew too high on th Fed's surprise rate cut in mid-April). The Put/Call Ratio: Option Sentiment as a Market Timing Tool The CBOE Equity Put/Call Ratio is a measure of the amount of bullish or bearish sentiment in the market. The "equity" refers to this ratio's focus only on stock options, not index options. Stock options give a better representation of the market's mood. Index options include too much institutional hedging to be considered an effective contrarian indicator on their own. Nasdaq 100 Trust (QQQ) vs. CBOE Equity Put/Call Ratio Here, the equity Put/Call Ratio reaches peaks in January around the 90% mark, signalling the QQQ's short-term rally in January. But then as the ratio of puts to calls falls back to the 40% area, this signals a coming decline in February and again points to another drop during the last leg down in late-March. Yet after the nasty downtrend in this chart, option speculators again became fearful in early-April, sending the ratio up above 80%, and a subsequent reading to 85% on a secondary low, set in place an April reversal back up to the 50 area on the QQQ in the just the next two weeks. Stated simply, the equity put/call ratio is the percentage of puts (options traded expecting a drop in stocks) that are trading relative to calls (options traded expecting a rise in stocks). When the percentage of puts to calls increases, it indicates rising fear in the market, which we interpret as a buy signal at extremes (as shown by moves above 80% in the chart, or moves above the upper 21-day Bollinger Band). Moves down below the lower 21-day Bollinger band (the lower blue band in the bottom chart) or moves touching the 40% area signify investor greed, usually marking important short- term tops as buying power is exhausted.