Table of Contents
- What Is the CBOE Volatility Index (VIX)?
- Understanding How the VIX Index Functions
- Applying VIX Volatility to the Broader Market
- How VIX Values Are Calculated
- The History and Development of the VIX
- Comparing VIX Movements With S&P 500 Trends
- Trading Strategies for the VIX
- What Does the VIX Tell Us?
- How Can an Investor Trade the VIX?
- Does the Level of the VIX Affect Option Premiums and Prices?
- How Can I Use the VIX Level to Hedge Downside Risk?
- What Is a Normal Value for the VIX?
- The Bottom Line
What Is the CBOE Volatility Index (VIX)?
Let me explain the CBOE Volatility Index, or VIX, which you might know as the Fear Index. It's a real-time index that investors like you and me use to gauge market sentiment and risk. Essentially, it shows the expected volatility of the S&P 500 over the next 30 days, acting as a direct measure of investor fear and uncertainty in the market.
You see it referred to by its ticker symbol, VIX, created by the CBOE Options Exchange and now maintained by CBOE Global Markets. In trading and investing, it's vital because it quantifies market risk and how investors feel about it.
Key Takeaways
- The VIX measures the market's expectation of 30-day volatility for the S&P 500.
- Values above 30 signal greater fear and uncertainty, while below 20 indicate stability.
- You can use the VIX to assess risk and trade related futures and options.
- It rises when stocks fall, showing increased volatility and anxiety.
- Introduced in 1993 and updated in 2003 with Goldman Sachs input, it's a key U.S. equity volatility indicator.
Understanding How the VIX Index Functions
The VIX measures the magnitude of price movements in the S&P 500, which is its volatility. When price swings are dramatic, volatility rises, and so does the VIX; calmer periods mean lower levels.
If you're a trader, you can use VIX futures, options, and ETFs to hedge or bet on volatility changes. Volatility measurement comes in two ways: historical, based on past prices with stats like mean and standard deviation, or implied, which the VIX uses from options prices.
Options prices reflect the probability of stock movements to certain levels, and models like Black-Scholes factor in volatility. Since these prices are public, they reveal forward-looking implied volatility for the underlying security.
Applying VIX Volatility to the Broader Market
The VIX was the first benchmark from CBOE for future market volatility expectations. It's forward-looking, built from implied volatilities of S&P 500 options, representing 30-day volatility expectations for this broad U.S. market indicator.
Since 1993, it's become a global gauge of U.S. equity volatility, calculated in real time from S&P 500 prices. Values are available from 3 a.m. to 9:15 a.m. and 9:30 a.m. to 4:15 p.m. EST, with extended dissemination since 2016.
How VIX Values Are Calculated
VIX calculations use CBOE-traded SPX options expiring on the third Friday monthly and weekly on other Fridays, only those with 23 to 37 days to expiry.
The complex formula averages weighted prices of SPX puts and calls across strike prices to estimate S&P 500 volatility. All options need valid bids and asks to reflect market views. For details, check the VIX white paper's step-by-step calculation section.
The History and Development of the VIX
Back in 1993, the VIX started with implied volatility from eight S&P 100 at-the-money options, when derivatives were still developing.
By 2003, CBOE partnered with Goldman Sachs to update it, using a broader S&P 500 options set for better accuracy on future volatility. This methodology persists and applies to other volatility indexes.
Comparing VIX Movements With S&P 500 Trends
When markets fall, VIX levels, fear, and volatility rise; when they rise, these drop. The S&P 500 and VIX often move inversely: sharp S&P drops push VIX up, and vice versa.
As a rule, VIX over 30 links to high volatility from uncertainty and fear, often in bear markets, while below 20 means stable, low-stress periods.
Trading Strategies for the VIX
The VIX made volatility tradable via derivatives. CBOE launched VIX futures in 2004 and options in 2006, creating a new asset class for pure volatility exposure.
Traders, institutions, and hedge funds use these for diversification, given volatility's negative correlation to stock returns—stocks down, volatility up. You can't trade the VIX directly, but through futures, options, or ETPs like VIXY or VXX.
Options and futures trade on CBOE and CFE. Advanced traders use VIX to price derivatives on high-beta stocks, where beta shows stock volatility relative to the market—for example, +1.5 beta means 50% more volatile.
CBOE offers variants like VIX9D for nine-day volatility, VIX3M for three months, VIX6M for six months, plus indexes for Nasdaq-100 (VXN), DJIA (VXD), and Russell 2000 (RVX).
What Does the VIX Tell Us?
The VIX signals fear or stress in the stock market via the S&P 500, earning its Fear Index nickname. Real-time news can drive irrational behaviors, and higher VIX means more uncertainty, especially above 30.
How Can an Investor Trade the VIX?
You can't buy the VIX directly, but trade it via futures, ETFs, and ETNs that hold those futures.
Does the Level of the VIX Affect Option Premiums and Prices?
Yes, volatility drives option prices and premiums. Higher VIX means pricier options; lower VIX means cheaper ones.
How Can I Use the VIX Level to Hedge Downside Risk?
Hedge downside with put options, priced by volatility. Buy them when VIX is low and premiums cheap—before markets slide, when protection gets expensive. It's like insurance: get it when risk seems low.
What Is a Normal Value for the VIX?
The long-run average is around 21. Above 30 often signals high volatility and fear, tied to bear markets.
The Bottom Line
The VIX, or Fear Index, benchmarks future market volatility expectations. It's a key tool for you to assess risk and sentiment, aiding decisions. It rises in declines and falls in advances, acting inversely to trends. Engage via linked products to leverage movements, and note high levels above 30 for volatility in hedging and pricing.
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