Almost everyone knows the stock market has times of volatility. Even those in the general public without any skin in the investment game can follow along on the big waves based on the nightly news. The Dow Jones Industrial Average falling almost 400 points in a day or the S&P 500 losing 100 points is a big deal. But there's also lower-scale volatility with certain stocks and funds. Volatility ETFs let individuals trade — and potentially profit — based on that uncertainty.
What Is Volatility?
Volatility is how much — and how fast — prices in the market go up and down. The faster and farther a price falls or rises, the more volatile a stock or other asset may be. Here are some examples of volatility ranked from most volatile to least:
- A stock price drops or rises $15 in a single day
- A stock price drops or rises $15 in a couple of days
- A stock price drops or rises $2 in a single day
These are simple examples, and the percent a stock price rises or falls can play a role in volatility. If shares are trading for $100 and change by $1, that's less volatile than if shares are trading for $5 and change by $1. One is a 1% change, while the other is a 20% change.
Trading Based on Volatility
Volatility ETFs let investors take a position on the market and benefit if that position turns out to be true. These investments are based on specific stocks. Volatility ETFs are funds based on market indexes.
Investors can hedge for volatility or against it. Standard volatility ETFs bet on the market being turbulent. If prices are rising or falling at fast rates, standard volatility ETFs gain. Inverse volatility funds, on the other hand, let investors bet on the market being more stable. They gain when prices don't rise and fall in volatile ways.