 Hey everybody, welcome to the video on the Wix and why it may be flawed. Now the Wix index is very popular and obviously it's reached it's achieved rather cult status and but I don't know if most people realize its flaws by design and also by its implementation and You know, and so even the results actually So let's go ahead and take a look at all of these issues in this video My name is Hari Swaminathan and I've been trading options for about 10 years now I've been self-taught in the sense that I'm not coming from Wall Street background or anything like that. I also found it optiontiger.com in 2012 about five years old now on my website You'll see the complete roadmap from a beginner to very advanced levels on options. I Also quickly want to show you my Udemy channel Udemy.com is the leader in online courseware and Here I have about 26,000 students 24 courses and about 2,500 reviews and most of it is all four star and five star and these are all the courses that I have over here Including the course on the Wix which is what I was going to give everybody for free, right? That's right there So let's talk about the Wix index itself So the Wix was originally designed after the Black Monday 1987 October When the Dow Jones crashed 22% in one day so ever since then they were looking for some kind of a reliable volatility indicator and they decided on something called the Wix and its official role was the volatility index and that's where it gets its vix name and over time they also Started calling it the fear index all options would need an underlying asset and therefore the closest one they could find Was the slash Vx, which is the futures now Just giving you a brief of the of the overall analysis First of all in its role as the volatility index, which is its primary and official role It comes out zero and I'll show you why I think it's zero Then in the role of the fear index does a pretty bad job But I'll give it 50% on that on that front and then there are various other Factors as well smaller, but ultimately does result in some bad information coming from the Wix and you know ultimately that that does Impact especially retail traders and investors because that's the only one they look at is the Wix index for any kind of fear But let's go look at all these details as we go along So from its design itself, you know The design was to make it a volatility index because they felt that they needed a new Market barometer for something called volatility after the October 87 clash then over time it developed its nickname as well the fear index and Now these are the important things to understand the Vix itself is not tradable like the spx The spx is also not tradable But its options and futures are and that's why they went with the underlying for the Vix as the Slash Vx, which is the futures now the way the futures are structured is they only give you like three-month contracts in the in the future So, you know right now, maybe they will have one for February March and April so and then the The Vix itself is calculated based on the somewhat around the second month so in the in the mid period of this three-month you know risk horizon and So the Vix basically looks at on an on average about 1.5 months into the future So that's its first shortcoming. I think I mean if you're going to look at the Vix as a measure of underlying fear in the markets I think we can all agree that 1.5 months is not at all a good horizon at all in fact We have to go much much more than that and then in the design of the Vix itself Call options are completely ignored So apparently volatility depends only on the downside and not the upside I don't even know why they put it that way I guess, you know it that tells you that it was being designed more as a fear index than the then the volatility index because volatility has to You know be represented of both sides. I think you know, so the average true range for example is Indicator that's available that looks at both the upside and the downside and in this case the Vix just doesn't look at the upside at all So without calls, you know, how can we think of this as a volatility index? I fail to understand that Then the futures as I mentioned, you know, the futures also have its limitation being that it's only, you know three months ahead and The the futures behave very differently from the Vix so it's not actually correlated so this is the Recapping of the volatility, you know, it does not consider call options. The Vix value is based on spx puts demand only Which I should add calls increased you to the math imbalance. Okay, so there's something called a put call parity relationship and that and all options have to Sort of, you know comply with that with that rule because it's all mathematical at the end of the day So because of the put call parity relationship the call options will increase in value When the stock is actually going down On a relative basis that is so, you know, that's again another sort of, you know indicator that Something's not right with this thing. This gives rise to arbitrage opportunities but these will be immediately closed down because any Any sort of group that's trying to take advantage of that will be will be closed down by the others It'll be open for a few seconds Maybe and a few people might take advantage but mostly it'll get closed right away now Let's look at it as a fear index It does a pretty bad job. I would say it's 50% at best. That's because of the risk horizon I mean, it's only about 1.5 months and so what happens after you know, one and a half months. We don't know So it installs fear for all the wrong reasons and yes It does calculate a little bit of fear index at least for the short term. So I'm giving it a 50% credit or that So now It so happens that the Vix index is pretty much the only indicator available to retail investors and traders when they're using options and You know at times it'll play a role that harms investors because of all these Inconsistencies with its design its structure and its implementation They tend to give you wrong wrong results and unfortunately the retail folks have nothing to go by except for the Vix index and Now we'll also look at the Vix of the Vix. So I'm talking about the volatility of the volatility index itself So and you'll see that that is a pretty much unbelievable and we'll also look at the flash crash day Which is in May 2010 and where within 20 minutes the SPX crashed hundred points got it all back within the next hour and Became a pretty costly learning curve for many for many reasons not just the Vix and let's be clear The Vix did not cause this one, but it's the way it behaved that day Could have resulted in at least the retail traders who are looking at the Vix at that time To to have to face some losses there So now let's go over to the thinkorswim platform And I just want to show you a little bit of all these things and so, you know, hopefully that will that will Introduce many elements in in your mind that you know, yes, the Vix is not designed fundamentally It's not designed, you know for volatility and it's more of it is designed for fear rather than volatility So anyway, let's take a look at these examples on the thinkorswim platform In some of the smaller effects smaller but pretty serious is also you can see it in the flash crash and That happened in May of 2010, I believe to be clear the Vix did not cause this flash crash But with its behavior that day It did mislead some investors based because you know, the whole thing was that it went up and down so quickly Like this is the actual Chart of the S&P going down. So, you know up till here it was like a normal breakdown So the market was a down day that day and somewhere around here it started collapsing in fact And then it goes all the way here and then it comes back and at the close pretty much, you know, equal where the collapse started And so this is really a very interesting Thing that happened and even the CBOE says it climbed over 40 which is a level not seen in more than a year So the you know, this kind of vicious turns Tend to give the wrong answer because it first of all blows the Vix above Normal on the upside and as well as as the downside So it's basically overreacting on both ends and it caused a lot of grief that day in terms of The investors getting burned, of course, you know, you cannot like I said, you cannot pinpoint the the flash crash itself to The Vix but in its effects. Yes, pretty much it it did that so then what happened was, you know, I wrote this post and Actually, this became the number one post in on google that time and I checked it now. It's still the number one on this area, which is, you know, stop loss and flash crash so this one Was read by many lawyers as well and they started calling me and about if I knew any customers who had Been burned by this, you know, I didn't have anyone personally But I knew that there were plenty of them out there And so I included their names and things like that and I believe they've got like 300 cases going these people itself So anyway, so these kind of small things the the Vix can have an impact and it did on that particular day And then this article came on CNBC just last week, you know, second feb 2017 The headline was Wall Street's fear index hits its lowest level in a decade and it's unclear why So this is a pretty, you know, funny statement. There's a lot of irony to it. And, you know, so this is the article that came out That something strange happened to the fear index. It fell and broke below 10 Now, this is the first time it's broken below 10 since 2007 And then, of course, all the blame game starts that, you know, blame it to an algorithmic Glitch or some other anomaly, but, you know, it's difficult to pinpoint the exact cause So this is the point, you know, it can behave unpredictably at certain times So now what I want to do is just quickly show you on the thinkorswim platform What exactly we are talking about when when we're saying it's not, you know, it's not correlated and things like that So if you look at this chart, here we are showing the slash VX futures and here we have the VIX index and both these charts are for the last 10 days at 30 minutes each bar Same thing here as well. And you can notice this is, of course, the day that they're talking about even on the CNBC article where it really went down, you know, below 10 for no reason But that same day in the, you know, on the slash VX, you'll see there's no movement at all I mean, it's just very, very natural. That's the left side of the graph. If you see, it's the same day And there's really nothing there at all This causes misleading information, especially when it's a sudden event like that And then, of course, you'll see, even in the rest of the graph, there is Not real consistency. I mean, if you see here, now the VIX is going down here. It's actually, you know, on the VX It's actually going up And so what kind of an underlying and what kind of an option relationship is this It's certainly one that cannot be trusted because the future is working a different way So, for example, if there is an event tomorrow That is expected to cause some volatility, like let's say the election results or something like that Then the VIX futures will actually not show May not show any sort of increase in the value for the slash VX because We know that the futures expire at the end of the month And so tomorrow being not the end of the month, it only considers what will the futures rate be at the end of the month And therefore it completely skips any events that happens tomorrow So there's a lot of flaws like that in the index itself Now this is also even in the last day here that is on Friday, this past Friday If you look at the price action, so here the VIX futures seems to have Dropped a lot and if you look at the On the last day of the VIX, it's increased Correspondingly, but just the other side. So it's you know, it's actually correlating inversely So these are all the small problems with the VIX and the slash VX in that relationship itself So, you know, that's at a design level, you know, you design it based upon a certain underlying And if that relationship itself is not Found to be valid, then we have a problem here Now I just want to show you the Volatility of the VIX itself. So basically what we'll do is Okay, so here we have the VIX itself for the last 10 days, whatever Now if you go to see the option chain, so the option chain will be under analyze And we go to add simulated trades. So what you're seeing here is the VIX option chain. Okay, so it's the VIX option chain Now if you've seen this platform before then it may You you may clearly understand it. If not, let me just briefly tell you This is the date of expiry. It's going to expire in in a couple of days from now And this one's going to expire nine days from now and so on and so forth So this is the option chain going far out into time Now the other thing noticeable is this is the value of the volatility of this of this particular series So that's 128 and the one expiring in nine days is 100% and you can see generally it's like 100 plus 100 Or you know, 190s 80s, you know, that's where the general volatility is. So what does this tell you? This is telling you that in this In the next two days, it is expected to move Almost 128 percent of the value. I mean that is just crazy So this is what you call volatility of the volatility index, right? That's that's what we're looking at. We're looking at the volatility of the volatility index itself And that's 128 percent I mean that is just absolutely crazy So which by itself tells you there's something wrong with the volatility index because the volatility of the volatility index Should be a lot less. I mean certainly not over 100 percent And so, you know, that's another clue that there's something I'm not trying to say that there's anything intentional happening I'm just saying it's you know, the the factors that have gone into the VIX are just not right And therefore they're going to produce the wrong numbers and therefore the people that are looking at it for Trading or investing triggers. They're going to be doing the wrong thing But I think with this basic video, I hope you go away the understanding that the VIX has a number of issues with it Really, this VIX cannot be trusted. It's not giving us the right information. It doesn't look past one and a half months Its co-relationship with the with its underlying, which is the slash VX futures Doesn't always work. In fact, sometimes it works inversely And there's lots of other issues as well as mentioned in this video Anyway, I'll conclude here now and we'll get back to the little bit on part three that's coming up in a few days