Roller coaster ride in the market continues. It may be good for the day traders, but it creates anxiety for the rest of us. If you are a short-term investor, keep your stop losses tight. Today, the market is moving higher because of positive report from Institute for Supply Management (ISM). It said that its non-manufacturing index moved to 50.6 in October from 50.9 in September. The index was expected to hit 52.0 in October. Initially, I thought the market was going to tank because the index moved down compared to previous month. However, traders like the fact that ISM’s new orders and prices indexes both showed growth from September.

A pair of employment reports also helped stocks. Automatic Data Processing and consultancy Macroeconomic Advisors reported a 203,000 drop in private-sector jobs last month, as expected by economists and smaller than September’s decline. Outplacement firm Challenger, Gray & Christmas said that layoffs announced by U.S. companies in October fell to the lowest reading since March 2008. What a relief!

The Federal Reserve’s interest-rate-setting committee will conclude its two-day meeting today by 11:30am PST. No change in rates is expected, but every active trader is going to analyze the comments from Fed. The Fed may not increase the interest rates, but if they say something negative about economy growth, the market will test the new lows. Otherwise, enjoy the higher prices in the stock market for few more days!

Chicago Board Options Exchange’s volatility index (VIX) jumped to its highest level yesterday since Sept. 3 as stocks slipped lower for the third day in a row. I love higher VIX, that’s when my option trades are more profitable. This may not be the appropriate statement given the current market condition! But, that’s the fact. I buy stocks and sell options when the VIX hits high. When everyone is panicked that’s when you should go for your favorite stocks and options. VIX is around 28.22, well above the recent trend.

Numbers from Institute for Supply Management (ISM) yesterday spooked many investors and caused huge drop in all indexes. ISM , a group of purchasing managers, reported that its index of manufacturing activity was at 52.6 in September, down from 52.9 a month earlier but still reflecting an expansion for the second consecutive month. Any reading above 50 indicates growth in manufacturing activity; below 50 is contraction. We are still in growth mode, not as much growth as you would expect, but still the manufacturing industry is picking up strength.

On the other side, today’s employment numbers are bad. This is going to be bad for many more months to come until businesses gain confidence. I am not going to turn negative on the market because of these numbers. I personally know how hard to hire right people at this time. Unemployment situation will turn around, not sure when. I am continuing to buy good stocks at better prices. More fear in the market is good for prudent investors.

Related Link: Fear Factor

When you see a panicked market, how do you measure the fear? VIX helps you to do just that. CBOE introduced Volatility Index (VIX) in 1993. It is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX indicates how fearful and volatile the stock market is.

VIX provides minute-by-minute snapshot of expected stock market volatility over the next 30 calendar days. VIX is calculated from the prices of S&P 500 options for various strike prices. More details and sample calculations are here.

VIX reached the record close of 80.86 in November 2008 at the height of economic crisis. It’s now close to 43. Not long ago, anything above 30 indicated high level of fear. VIX hasn’t closed below 30 in the last four months. Understanding of VIX would help you to gauge the market fear and take the appropriate investment decisions.

When the VIX is high, the stock options are priced higher. For example, if the VIX is at 25, Google March 300 calls may be priced at $23. Right now, Google March 300 calls are trading at $37.50 with the VIX at 43. This is a simplistic example – in reality, the option pricing is also depending on stock’s implied volatility. If you are an option seller, higher VIX would help you make more money. If you own stocks and want to write covered calls on the stocks, higher VIX would fetch you higher option premium. On the other hand, if you want to buy puts to protect your stocks, higher VIX would make you to pay more for put option premium.

When the VIX climbs higher, the general sentiment is that market is reaching the bottom. Traders used to believe that with all the fear in the market, there would be some kind of capitulation. That theory was proved wrong in the last few months. VIX keeps climbing higher; there is no sign of capitulation.

VIX is the good indicator to see the market trend. I personally use VIX to decide whether to sell options. Higher VIX inflates the option premiums and provide a good opportunity to sell put or call options.

CBOE introduced VIX options in February 2006. You can bet on VIX direction and buy/sell options on VIX. You can also use VIX options to hedge your investments against any future volatility. Stock options expire on third Friday of each month. However, VIX options expire on third Wednesday of each month.

If you are anxious about when the stock market carnage would end, keep watching VIX – the fear factor.

Related Links: VIX options guide | Economy in free fall