Using the oil VIX to forecast energy prices | Volatility and the VIX

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Using the oil VIX to forecast energy prices

Wednesday, 13 August 2008 13:53

The VIX is a great tool for understanding investor sentiment relative to stocks. Traders were able to use the VIX to predict the most recent rally in stocks in June. If you are interested in understanding investor sentiment in other markets through a volatility index like the VIX then this article is for you. The formula used to derive the VIX's values can be applied to just about any widely traded index option and that includes oil futures options.

Oil prices have a version of the VIX called the Oil VIX (OVX) that operates the same way the stocks version does. When the oil VIX hits extremes oil prices become more prone to reversals. Unlike equities however, the oil VIX is positively correlated with oil prices because higher risk levels will increase oil prices rather than discount them. In the video, I will show you how the channel between extremes in oil market sentiment accurately predicted changes in the price trend of oil itself through 2008.

This is particularly useful now as the oil VIX is approaching another inflection point making an oil price increase more likely. This is helpful for all traders because of the intermarket affects of an increase in oil prices. Higher energy costs will be a bad thing for stocks, good for bonds, bad for the USD and great for commodity currencies. The oil VIX is one more way to manage risk and increase profit opportunities.