Volatility Index (VIX)

QUOTE AND NEWS
Forbes  Jul 21  Comment 
A flurry of earnings and economic news this week may divert the stock market’s attention away from global violence—at least for now.
Clusterstock  Jul 21  Comment 
Ari Wald, a technical analyst with Oppenheimer, is out with a note this morning that outlines five signals that indicate a bull market top. "As it stands," Wald writes, "we think the absence of these signals argue against an imminent end to the...
Yahoo  Jul 18  Comment 
Yesterday when news broke of the tragic crash of Malaysian Airlines flight 17 the VIX popped by 17%. It’s just the latest example of an external event that shouldn’t really impact the stock market doing just that.
Clusterstock  Jul 18  Comment 
Dave Lutz of JonesTrading passes along the top topics about which traders are talking today: Euros noting how quiet it is despite the headlines as the globe digests the worst Air Tragedy since 9/11. Yesterday was the 8th largest VIX percentage...
SeekingAlpha  Jul 18  Comment 
By Dr. Duru: Thursday, July 17 was a tough news day that pressured the market in several ways. The S&P 500 (NYSEARCA:SPY) dropped 1.2% and returned to where it traded at the end of June. The primary uptrend for the S&P 500 ends with a decisive...
SeekingAlpha  Jul 18  Comment 
By Jonathan Kinlay: Background to the Market Timing Approach In an earlier article, I discussed how to use marketing timing techniques to hedge an equity portfolio correlated to the broad market. I showed how, by using signals produced by a...
TheStreet.com  Jul 18  Comment 
NEW YORK (TheStreet) --It was a sea of red on Wall Street today.  An image of the StockTwits Heat Map shows that perfectly. Every major sector was down. Healthcare, technology, and financial sectors were hit especially hard. The S&P 500 dropped...
CNNMoney.com  Jul 17  Comment 
Fear returns to the stock market after Israel launches ground offensive in Gaza and a plane crashes in Ukraine.
Clusterstock  Jul 17  Comment 
Stocks are red and falling to their lowest levels of the day. The Dow is down 130 points, the S&P 500 is down 20 points, and the Nasdaq is down 57 points. The VIX is also surging higher. This plunge follows news that t hat a Malaysian...




 
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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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