This weekend, as I drove my oldest daughter to one of her many activities, she asked if she could ask me a question. I braced myself for something that may be more appropriate for her mother to answer. However, I was surprised when she uttered the words, “Dad, what’s VIX?”
Here’s a summary of my attempt to explain VIX to a 10 year old –
Let’s say the amount of money you have in the bank goes up and down with the markets, like those numbers I watch on TV in the morning. When the number goes up you would be happy and when the number goes down you would be worried.
Now if you are worried about losing money there is a way you can pay a small amount to protect from losing a large amount of money. When the market is moving higher very few people are worried about losing money so not many people are willing to pay that small amount. When the market is moving lower and more people are willing to pay for the protection against losing more money.
When more people want to pay for that protection the cost of that protection will move higher and when fewer people are willing to pay for that protection the cost will move lower. In a very complex way VIX measures how much demand there is for that protection – when people are more worried about the market VIX moves up and when people are less concerned about the market, and their money, VIX moves lower.
She looked at me, maybe she got it and maybe she didn’t, and said, “Dad can we go see the Paddington movie tomorrow?”