Volatility Index (VIX)

QUOTE AND NEWS
MarketWatch  Apr 2  Comment 
Two important systematic buy signals have been registered, bolstering the bullish case, says Lawrence McMillan.
SeekingAlpha  Mar 31  Comment 
By David Moenning: In our last missive entitled "A VIX Buy Signal Worth Watching", we reviewed an actionable buy signal using the VIX that is (a) easy to follow and (b) has proved its ability to put the odds in your favor over time. We received...
Benzinga  Mar 24  Comment 
Before we were so rudely interrupted by all the hullabaloo surrounding Janet Yellen's definition of a "considerable" amount of time (now known to be six months), we were looking at how the VIX could be used to help identify decent entry points for...
SeekingAlpha  Mar 21  Comment 
ByRobert Wagner: Recently I wrote a series of articles detailing investment strategies using the VIX, an index designed to quantify and measure the volatility of the S&P 500. The VIX index is unique in that it doesn't trend like most indexes, it...
Clusterstock  Mar 21  Comment 
The CBOE Volatility Index, aka the VIX, is a pretty weird metric in the financial markets. Volatility isn't exactly quantifiable because you can't observe it directly. However, options gurus figured out that you can derive it from options...
SeekingAlpha  Mar 21  Comment 
By David Moenning: Before we were so rudely interrupted by all the hullabaloo surrounding Ms. Yellen's definition of a "considerable" amount of time (now known to be six months), we were looking at how the VIX could be used to help identify...
SeekingAlpha  Mar 20  Comment 
By 99% Trader: There is lots going on in the markets these days, volatility is increasing, geopolitical risk is everywhere, and the markets are seeing a lot of froth. So much froth in fact that it's next to impossible to filter out the noise if we...
SeekingAlpha  Mar 19  Comment 
By David Moenning: Another day, another crisis averted. Phew! In case you were out and about or weren't glued to your Twitter feed at approximately 8:00 am eastern time Tuesday, comments made by Russian President Vladimir Putin were the source...
Mondo Visione  Mar 18  Comment 
CBOE Futures Exchange(SM) (CFE®) plans to extend CBOE Volatility Index® (VIX® Index) futures trading hours to nearly 24 hours a day, five days a week, beginning Sunday, June 22, CBOE Holdings Chief Executive officer Edward T. Tilly announced...




 
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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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