Volatility Index (VIX)

QUOTE AND NEWS
Mondo Visione  Sep 19  Comment 
The Chicago Board Options Exchange® (CBOE®) today was named "Equities Exchange of the Year" at GlobalCapital's(www.globalcapital.com) Global Derivatives Awards ceremony in London. According to the GlobalCapital Derivatives editorial team,...
SeekingAlpha  Sep 19  Comment 
By Chris Ciovacco: Supply And Demand When you get down to brass tacks, asset prices are governed by supply and demand. In the markets, the conviction of buyers relative to the conviction of sellers also plays a major role. Therefore, "I am...
SeekingAlpha  Sep 18  Comment 
By Vance Harwood: The CBOE's VXST futures have been trading for over six months now-enough time get a feel for how they behave. The CBOE provides historical data -on a per future basis (VSW), which requires some work to get it into a consolidated...
Mondo Visione  Sep 18  Comment 
Download this month's dashboard   HIGHLIGHTS: •   Dovish and broadly familiar statements from the Fed yesterday rounded off a period in which both the S&P 500 and the VIX have slightly gained, the U.S....
The Times of India  Sep 13  Comment 
NSE India VIX — volatility index or investors' fear gauge meter — is trading near its all-time low at 12.36%, impacting derivatives option price movement, thus making many F&O strategies futile.
The Economic Times  Sep 13  Comment 
Drop in market volatility can be attributed to investors’ growing confidence, encouraged by an economic recovery, aided by better corporate earnings.
Yahoo  Sep 12  Comment 
U.S. stocks fell on Friday, with major indexes on track to snap five-week winning streaks, as energy shares again led the market down.
The Economic Times  Sep 11  Comment 
Nifty options daily average turnover has also fallen 37 per cent during the month so far, indicating investor’s reluctance to participate in the markets, say analysts.
Clusterstock  Sep 9  Comment 
Nomura's bearish strategist Bob Janjuah believes the stock market could continue to rally to new highs given current market conditions.  "As I have said for at least a year now, until and unless we see a weekly close (ideally consecutive weekly...




 
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The volatility index ("VIX") is an index which measures expectations of volatility, or fluctuations in price, of the S&P 500 index. Higher values for the volatility index indicate that investors expect the value of the S&P 500 to fluctuate wildly - up, down, or both - in the next 30 days.

The index, commonly known by its ticker VIX, is also known as the "fear index" because a high VIX represents uncertainty about future prices. The index is calculated using the price of near-term options on S&P 500 index.[1] Because the value of an option is closely linked to the expected volatility of its underlying security, options prices can be a useful indicator of investors' expectations of volatility.

The VIX hit its historic high of 89.53 on October 24, 2008 on concerns about the 2008 Financial Crisis. Prior to this crisis, the VIX had peaked at 38 on August 8, 2002.

There is no security that realizes the VIX's "return" (like ETFs for regular indices). However, VIX-based futures contracts and options exist for professional investors. In January 2009, iPath launched two securities (VXX and VXZ) that track VIX futures rather than the VIX itself. These securities allow retail investors to speculate on the VIX.[2]

There are other volatility indexes which track expected volatility on other indices: VXD is used as an indicator of expected volatility of the Dow Jones Industrial Average and VXN is used for the NASDAQ 100 index.

What is volatility?

Volatility is the rate at which the price of a certain [security] moves. A security with high volatility has bigger fluctuations in price compared to a security with low volatility. The more quickly a price changes up and down, the more volatile it is. As such, volatility is often used as a measure of risk.

For example: A stock whose price went up 20% yesterday and went down 25% today is more volatile than a stock which increased 2% in both days.

Volatility can be observed by looking at past changes in stock price. The standard deviation of percentage changes in price is used to calculate observed volatility.

Volatility vs. Implied Volatility

Volatility is different from implied volatility, in the sense that volatility is observed by looking at past data, whereas implied volatility represents expectations about future fluctuations.

Volatility expectations, or implied volatility, is deduced from option prices (both call and put) on the underlying security -- since these expectations are reflected in market prices of the option. Higher fluctuation expectations mean that the option has a greater probability of ending in the money, and thus the option commands a higher price and vice versa. By inputting the option price, along with other variables such as maturity, interest rate, strike price and underlying security price, in a pricing model (e.g. Black-Scholes) it is possible to derive an estimate of the investor's expectation of future volatility.

The VIX is calculated by taking into account implied volatility on near-term S&P 500 options with different strike prices. Hence, it represents investor's expectations on how drastically the index may fluctuate in the near future.

Interpreting the VIX

"Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac's talents didn't extend to investing: He lost a bundle in the South Sea Bubble, explaining later, 'I can calculate the movement of the stars, but not the madness of men.' If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases." -- Warren Buffett [3]

The VIX is often referred to as the "Fear Index".[4] Although a high VIX does not represent a definite bearish signal on stock, the market fluctuates most during times of uncertainty. Historically, the VIX has hit its highest points during times of market turmoil and financial downturn.

VIX as a leading Indicator

According to research by CXO Advisory Group,[5] between 1990 and 2005, an extremely high VIX has been followed by periods of high returns on the S&P 500 index, in both short-term (1 month) and medium-term (1 year). The research defined high VIX as being 77% above its 63-day moving average. For example: When the VIX was 135% above its 63-day moving average, the S&P 500 returned 14 percent over the next year.

References

  1. CBOE paper on VIX, retrieved August 20, 2009
  2. Seeking Alpha, Retrieved April 23, 2009
  3. Annual letter to shareholder's of Berkshire Hathaway (2005), Retrieved 10/14/2008
  4. Motley Fool, 4/3/2007, Retrieved 10/14/2008
  5. CXO Advisory Group, Retrieved 10/14/2008
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