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What is the EU Volatility Index and how can you trade it?

The EU Volatility Index is the European volatility benchmark, giving traders an indicator of the near-term predicted levels of volatility in the European stock market. It’s designed to reflect investors’ sentiment and the overall level of economic uncertainty, by measuring the 30-day implied volatility of the Euro Stoxx 50 index.

Trading CFDs on the EU Volatility Index futures market presents potential trading opportunities. It offers an accurate and cost-effective way to take a view on European volatility, it is sometimes used it as a hedge against any existing exposure a trader may have to European market volatility.

The EU Volatility Index is similar to the more well-known US version – the Volatility (VIX) Index, which reflects investors’ view on US stock market volatility over the next 30 days through the S&P 500 index.

Key Points
  • The EU Volatility Index measures predicted European stock market volatility over the following 30 days, by measuring the average implied volatility of EU Stoxx 50 options
  • The index providers a gauge for near-term levels of market risk and uncertainty
  • You can trade CFDs on EU Volatility Index forward instruments
  • The EU Volatility Index has a long-term negative correlation to the Euro 50 index
  • Trading on the EU Volatility Index can be considered as a potential hedge, as the index usually rises when the markets are declining

How to trade the EU Volatility Index

There are some potential moves a trader in the index can make, based on the prevailing market sentiment. If you’re expecting equity markets to fall, you might take a long position in the EU Volatility Index, while simultaneously hedging against downward moves in the European equity market, such as the Euro 50, which is based on Europe’s benchmark market capitalisation-weighted stock index, comprising blue-chip eurozone stocks.

The EU Volatility Index has a negative correlation to the Euro 50 index on a long-term basis. In general, volatility usually rises during a bear market crash in indices.

One of the main risks when trading on the instrument is that volatility futures can rise significantly more than the underlying index might fall. For example, from 1 August to 30 September 2022, the Euro 50 index fell 12%, while the EU Volatility Index jumped 60%. In March 2023, the Euro 50 fell by 8%, while the EU Volatility Index leapt 77%.

Hedging in market downturns

As a result of this correlation, the EU Volatility Index tends to move to the upside when all other asset classes are declining. Therefore, some traders have considered it to be a relevent hedge in times of both global crises, like the 2008 financial crisis, and 24 August 2015 market meltdown, as well as EU-related crises, like the Greek debt crisis in 2015, Brexit in 2016, or the start of the Russia-Ukraine war in 2022.

How does the EU Volatility Index work?

A volatility index measures the expectancy of future stock index movements, and the EU Volatility Index measures expected volatility in the Euro Stoxx 50 index over the next 30 days.

The index value is an "annualised standard deviation", meaning that if the EU Volatility Index is at 20:
  • The market expects there to be a roughly 65% chance (1 standard deviation) that the Euro Stoxx 50 will be within a 20% range one year from now, and
  • A roughly 95% chance (2 standard deviations) that the Euro Stoxx 50 will be within a 40% range one year from now

Time horizons for standard deviation (also known as volatility) scale with the square root of time. So, to translate an EU Volatility Index value of 20 into how much the market expects the Euro 50 to move in the next 30 days (about 1/12th of a year), we divide by the square root of 12, or around 3.5. This means that when the EU Volatility Index is at 20, the market expects:

  • A roughly 65% chance that the index will be within a 5.7% (20 / 3.5) range one month from now, and
  • A roughly 95% chance that the index will be within an 11.4% (5.7 X 2) range one month from now

Standard deviation is a measure of variation of a set of values. A low standard deviation indicates that the values tend to be close to the mean (or expected value) of the set, while a high standard deviation indicates the values are spread over a wider range.

By opening the charts of the Euro 50 - Cash and EU Volatility Index, you can take a look at the correlation between the two indices, as well as the comparative volatility.