CBOE Volatility Index (VIX): the VIX measures the market's expectations of future volatility based on options prices of the S&P 500 index.
The CBOE Volatility Index, commonly known as the VIX, is a real-time index that reflects the market’s expectations for near-term price fluctuations of the S&P 500 Index (SPX). By analyzing the prices of SPX options with upcoming expiration dates, the VIX generates a 30-day forecast of market volatility. This volatility is often viewed as an indicator of market sentiment, particularly in terms of the level of fear among investors.
Created by the CBOE Options Exchange and maintained by CBOE Global Markets, the VIX is a critical tool for traders and investors, as it provides measurable insights into market risk and psychological sentiment.
The VIX serves as a real-time index reflecting market expectations for volatility over the next 30 days.
Investors use the VIX to assess market risk, fear, and stress when making investment decisions.
Various financial instruments, including options and exchange-traded products, allow traders to engage with VIX values.
Generally, the VIX rises when stock prices fall and decreases when stock prices rise.
The VIX aims to quantify the magnitude of price movements in the S&P 500, meaning that larger price swings indicate higher volatility. The index not only measures expected volatility but also allows traders to buy and sell VIX futures, options, and ETFs for hedging or speculative purposes.
Volatility can be assessed through two primary methods:
Historical Volatility: This method uses statistical calculations on past price data over a defined period to compute measures like mean, variance, and standard deviation.
Implied Volatility: The VIX uses this second method, which infers future volatility based on options prices. Options are derivatives whose pricing is influenced by the likelihood of a stock's price moving to a specific level (strike price). The VIX calculates its value based on the implied volatilities derived from the prices of S&P 500 options.
Extending Volatility to Market Level
As the first benchmark index for measuring future volatility, the VIX is constructed using the implied volatilities of S&P 500 index options, representing market expectations for 30-day future volatility. Introduced in 1993, the VIX has become a globally recognized metric for U.S. equity market volatility, with real-time calculations based on live S&P 500 prices.
VIX values are calculated using CBOE-traded standard SPX options, which expire on the third Friday of each month, as well as weekly SPX options. Only options that expire within a specific timeframe (more than 23 days and less than 37 days) are considered. The formula for calculating the VIX is complex, but it estimates expected volatility by aggregating the weighted prices of various SPX puts and calls across a range of strike prices.
Evolution of the VIX
Initially, the VIX was calculated based on the implied volatility of eight S&P 100 options. However, in 2003, the methodology was updated in collaboration with Goldman Sachs to include a broader set of options from the S&P 500 Index. This change allowed for more accurate assessments of future market volatility.
VIX vs. S&P 500 Price
The VIX typically moves inversely to the S&P 500. When the stock market declines, the VIX tends to increase, reflecting investor fear and uncertainty. Conversely, during market rallies, the VIX usually decreases. Generally, VIX values over 30 indicate significant market fear, while values below 20 suggest a more stable environment.
The VIX has facilitated the trading of volatility as an asset class through derivative products. The first VIX-based exchange-traded futures contract was launched in March 2004, followed by VIX options in February 2006. These instruments allow traders to gain pure exposure to volatility, with many institutional investors using them for portfolio diversification.
While investors cannot buy the VIX directly, they can trade through futures contracts, ETFs, and exchange-traded notes (ETNs) linked to the VIX. Examples include the ProShares VIX Short-Term Futures ETF (VIXY) and the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX).
The VIX serves as an indicator of fear or stress in the stock market, often referred to as the "Fear Index." A higher VIX indicates greater uncertainty and fear, while lower values suggest a calmer market environment.
Yes, the VIX significantly impacts options pricing. Higher VIX levels generally correlate with increased option premiums, while lower VIX levels lead to more affordable options. This relationship underscores the importance of volatility in options trading.
Investors can hedge against downside risk by purchasing put options, which are influenced by market volatility. Savvy investors often buy these options when the VIX is low and premiums are inexpensive, as they tend to become more expensive during market downturns.
Historically, the VIX averages around 21. Values above 30 suggest high volatility and investor fear, often associated with bearish market conditions.
The CBOE Volatility Index (VIX) quantifies market expectations of volatility, offering valuable insights for traders and investors. By gauging market sentiment and potential risk, the VIX aids in making informed trading decisions. Although the VIX itself cannot be traded directly, various financial products allow for exposure to its movements.
When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.
Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.
