What is the VIX?
The CBOE Volatility Index (VIX) is widely considered the foremost indicator of stock market volatility and investor sentiment. It is a measure of the market’s expectation of near term volatility of the prices of S&P 500 stock index options.
The Chicago Board Options Exchange (CBOE) introduced the VIX in 1993 in order to measure the market’s expectation of 30-day implied volatility of at-the-money S&P 100 options. Since then, the index has grown to become the standard for gauging market volatility in the US stock market. This has earned it the monikers ‘fear index’ and ‘fear gauge’.
In 2003, encouraged by the ever-growing significance of the index, the CBOE and Goldman Sachs updated the VIX to reflect its benchmark status. The VIX is now based on a wider index, the S&P 500, allowing for a far more accurate depiction of expected market volatility.
Understanding the VIX
As a volatility gauge, the VIX generally portrays investor fear or complacency. The typical indicative value is 30. When the VIX reading is above 30, it implies high volatility and inherent fear in the market. On the other hand, when the reading is below 30, it denotes complacency, or rather, less tense times in the market.
In highly volatile times, investors usually exercise increased caution in the markets and vice versa. This innately inversely correlates the VIX with the S&P 500. When the S&P 500 goes down, the market interprets this as fear in the market, which consequently pushes the VIX higher.
Still, the VIX measures volatility, and does not necessarily indicate future market direction. Historically, the VIX posted its all-time high of 80.86 on November 20, 2008, which was during the global financial crisis. Its all-time intraday low of 8.56 was posted on November 24, 2017, and the fact that it was Black Friday probably helped impact the VIX.
VIX Trading Information
- MT4 Symbol: VXX
- Trading Time: Monday – Friday 08:00 – 17:00 Eastern Time
- Country: United States
- Currency: USD
- Exchange: CBOE
Calculation of the VIX
Unlike stock indices, such as the S&P 500, which are calculated using prices of component stocks, the VIX is a volatility index. Its computation involves averaging the weighted prices of SPX (S&P 500) Puts and Calls over a wide range of strike prices, allowing it to estimate the near-term volatility of option prices. As stated above, the only major change to the formula was enacted in 2003, when the index was expanded from the S&P 100 to include the wider S&P 500. Previously, the index computation used only at-the-money options, but after it was updated, a broad range of strikes are now included.
While the whole formula of the VIX is contained in a 15-page CBOE whitepaper, it follows the mathematical step-by-step logic below when computed:
- Options with expiry times of between 23-37 days are selected
- The contribution to the total variance of each option is calculated
- The total variance for the first and the second expiration is calculated
- Next is the derivation of the 30-day variance, which is done by interpolating the two variances
- The square root is computed to obtain volatility as a standard deviation
- The VIX is finally derived by multiplying the standard deviation (volatility) by 100
The calculation explains that the VIX is simply Volatility times 100. As such, when the VIX reading is 20, it basically means that the 30-day annualized volatility is 20%.
Trading the VIX
The CBOE introduced the first exchange-traded VIX futures contract on its exchange on March 24, 2004. In February 2005, VIX options were also launched and have now become one of the most traded assets on the CBOE exchange. Due to the typically negative correlation with the stock market, VIX options and futures have served as a natural hedge for positions in the stock and indices market.
Away from the futures and options market, AvaTrade enables investors to trade the VIX in a revolutionary manner. The index is offered as the Inverse VIX ETN (VXX), giving traders the lucrative chance of maximizing potential profitability in a risk-controlled environment.
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