What is the CBOE Volatility Index (VIX)?
The CBOE Volatility Index (VIX) is a real-time index that represents market expectations for the relative strength of short-term price movements of the S&P 500 Index (SPX). It is derived from the price of SPX index options near expiration, thus producing a 30-day forward forecast of volatility. Volatility, or the speed at which prices change, is often seen as a way to gauge market sentiment, particularly the degree of fear among market participants.
This index is better known by its ticker symbol and is often referred to simply as “VIX.” It is created by CBOE Options Exchange and maintained by CBOE Global Markets. It is an important indicator in the trading and investment world because it provides a quantifiable measure of market risk and investor sentiment.
Important points
The CBOE Volatility Index (VIX) is a real-time market index that represents the market’s expectations for volatility over the next 30 days. Investors use the VIX to measure the level of risk, fear, or stress in the market when making investment decisions. Traders can also trade VIX using a variety of options and exchange-traded products, and use VIX values to price derivatives. The VIX typically rises when stock prices fall and falls when stock prices rise.
How does the CBOE Volatility Index (VIX) work?
The VIX attempts to measure the magnitude of price changes (i.e., volatility) of the S&P 500. The more dramatic the index’s price changes, the higher the level of volatility. The same is true vice versa.
In addition to being an index that measures volatility, traders can also trade VIX futures, options, and ETFs to hedge or speculate on changes in the index’s volatility.
Generally, volatility can be measured using two different methods. The first method is based on historical volatility, which uses statistical calculations of previous prices over a certain period of time. This process involves calculating various statistical numbers such as the mean (average), variance, and finally standard deviation of the historical price dataset.
The second method used by the VIX involves estimating the value of the VIX implied by the option price. Options are derivative instruments whose price depends on the probability that the current price of a particular stock will move enough to reach a certain level (called the strike price or strike price).
Various option pricing methods (such as the Black-Scholes model) include volatility as an essential input parameter because the probability of such a price change occurring within a particular time frame is represented by the volatility coefficient. Masu.
Option prices are available on the open market and can be used to derive the volatility of the underlying security. Such volatility implied by or inferred from market prices is referred to as implied volatility (IV) of future expectations.
Extend volatility to market level
VIX is the first benchmark index introduced by CCOE to measure market expectations for future volatility.
A forward-looking index, the index is constructed using the implied volatility of S&P 500 Index options and is a market estimate of the 30-day future volatility of the S&P 500 Index, which is considered a leading indicator for the entire U.S. stock market. represents the prediction.
Introduced in 1993, the VIX is now an established, globally recognized indicator of US stock market volatility. Calculated in real time based on live prices of the S&P 500 index. Calculations are performed and values are relayed from 3:00 a.m. to 9:15 a.m. ET and from 9:30 a.m. to 4:15 p.m. ET. The CBOE began disseminating VIX outside of U.S. trading hours in April 2016.
VIX value calculation
VIX values are calculated using standard SPX options on CBOE trades that expire on the third Friday of each month and weekly SPX options that expire on all other Fridays. Only SPX options with an expiry date of more than 23 days and less than 37 days will be considered.
This formula is mathematically complex, but in theory it works like this: Estimates the expected volatility of the S&P 500 Index by aggregating the weighted prices of multiple SPX puts and calls over a wide range of strike prices.
All such eligible options have valid non-zero bid and ask prices that represent the market’s perception of which options’ strike prices will be hit by the underlying stock during the remaining period until expiration. must be present.
For detailed calculations with examples, please see the VIX Index Calculation: Step-by-Step section of the VIX Whitepaper.
Evolution of VIX
VIX was calculated as a weighted measure of the implied volatility of eight at-the-money put and call options on the S&P 100 when it was created in 1993, when derivatives market activity was limited and in a growth phase. Ta.
As the derivatives market matured, a decade later, in 2003, CBOE partnered with Goldman Sachs to update the way it calculated VIX differently.
We then started using a wide range of options based on the broader S&P 500 index. This provides a more accurate picture of investors’ expectations for future market volatility. The methodology adopted is still valid and is also used to calculate various other variations of volatility indices.
VIX vs. S&P 500 price
Volatility values, investor fear, and VIX values all rise when markets are falling. As the market moves forward, the opposite is true: index values, fear, and volatility decrease.
The S&P 500 and VIX often exhibit opposite price movements. When the S&P plummets, the VIX rises and vice versa.
Note
As a rule of thumb, VIX values above 30 are generally associated with greater volatility due to increased uncertainty, risk, and investor fear. Generally, a VIX value below 20 corresponds to a period of stable and stress-free markets.
How to trade VIX
The VIX paved the way for the use of volatility as a tradable asset, albeit through derivative products. CBOE launched the first VIX-based exchange-traded futures contracts in March 2004, followed by VIX options in February 2006.
These VIX-linked products enable pure volatility exposure and have created a new asset class. Active traders, large institutional investors, and hedge fund managers use VIX-linked securities to diversify their portfolios because historical data shows a strong negative correlation between volatility and stock market returns. In other words, when stock returns fall, volatility rises and vice versa.
Like all indices, you cannot buy the VIX directly. Alternatively, investors can take positions in VIX through futures and options contracts, or VIX-based exchange traded products (ETPs). For example, the ProShares VIX Short-Term Futures ETF (VIXY) and the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX) are two products that track specific VIX variant indices and take positions in linked futures contracts.
Note
Options and futures based on VIX products can be traded on the CBOE and CFE platforms, respectively.
Active traders who employ proprietary trading strategies and advanced algorithms use VIX values to price derivatives based on high-beta stocks. Beta measures how much a particular stock price is likely to fluctuate relative to movements in a broader market index.
For example, a stock with a beta of +1.5 means it is theoretically 50% more volatile than the market. Traders who bet through options on such high beta stocks utilize the VIX volatility value in appropriate proportions to correctly price their option trades.
Given the popularity of the VIX, the CBOE now offers several other variants to measure broad market volatility.
An example is the CBOE Short-Term Volatility Index (VIX9D), which reflects the nine-day expected volatility of the S&P 500 index. CBOE S&P 500 3-Month Volatility Index (VIX3M). CBOE S&P 500 Six Month Volatility Index (VIX6M). Other market index-based products include the Nasdaq-100 Volatility Index (VXN). CBOE DJIA Volatility Index (VXD). CBOE Russell 2000 Volatility Index (RVX).
What does the VIX tell us?
The CBOE Volatility Index (VIX) is widely known as the “fear index” because it uses the S&P 500 Index as a proxy for the overall market to indicate the level of fear or stress in the stock market. The availability of real-time news coverage can encourage irrational investor behavior. The higher the VIX, the greater the level of fear and uncertainty in the market, with levels above 30 indicating very high uncertainty.
How can investors trade VIX?
Does the level of VIX affect option premiums and prices?
Yes, that’s right. Volatility is one of the main factors affecting the prices and premiums of stock and index options. VIX is the most widely watched indicator of overall market volatility, and therefore has a significant impact on option prices and premiums. A higher VIX means a higher option price (and therefore a higher option premium), and a lower VIX means a lower option price or a lower premium.
How can I use VIX levels to hedge downside risk?
Downside risk can be adequately hedged by purchasing put options, the price of which depends on market volatility. Smart investors tend to buy options when the VIX is relatively low and put premiums are low. Such protective puts generally become more expensive when the market is declining. Therefore, like insurance, it is best purchased when the need for such protection is not obvious (i.e., when investors perceive that the downside risk of the market is low).
What is the normal value of VIX?
The long-term average of the VIX is approximately 21. High levels of the VIX (usually above 30) can indicate increased market volatility and fear and are often associated with bear markets.
conclusion
The CBOE Volatility Index (VIX) quantifies market expectations for volatility and provides investors and traders with insight into market sentiment. This helps market participants assess potential risks and make informed trading decisions, such as whether to hedge or take directional trades. Although the VIX itself is an index and cannot be traded, there are funds and notes that investors and traders can participate in to gain exposure to the index.
