CBOE Volatility Index (VIX)

The CBOE Volatility Index, or VIX, is the index for the implied volatility of S&P 500 index options listed on the Chicago Board Options Exchange.

CBOE Volatility Index (VIX)

The CBOE Volatility Index, or VIX, is the index for the implied volatility of S&P 500 index options listed on the Chicago Board Options Exchange.  Due to its popularity as a barometer of investor sentiment and market volatility, the VIX has supplanted the older VXO as the preferred volatility index.

VXO was a measure of implied volatility calculated using 30-day S&P 100 index at-the-money options. The VIX Index was developed by Prof. Robert E. Whaley in 1993 and is a registered trademark of the CBOE.

CBOE Volatility Index Calculation

VIX is a weighted blend of near-term market volatility expectations for a range of options on the S&P 500 index.  It is calculated as the square root of the par variance swap rate for a 30 day term initiated today.  The VIX uses variance swaps as opposed to volatility swaps (volatility being the square root of variance) as a variance swap can be replicated through normal puts and calls.  The volatility swap on the other hand, requires dynamic hedging.  The VIX is quoted as an annualized standard deviation. The VIX is published in real-time by the CBOE.

Application of CBOE Volatility Index

The CBOE Volatility Index is quoted in percentage points and represents the anticipated movement in the S&P 500 index over the next 30-day period, which is then annualized. As an example, if the VIX is 15, then anannualized change of 15% over the next 30 days is expected; thus one can infer that the index option markets expect the S&P 500 to move up or down 15%/√12 = 4.33% over the next 30-day period. That is, index options are priced with the assumption of a 68% likelihood (one standard deviation) that the magnitude of the S&P 500's 30-day return will be less than 4.33% (up or down).

Although the CBOE Volatility Index is often called the "fear index", a high VIX is not necessarily bearish for stocks.[4] Instead, the VIX is a measure of market perceived volatility in either direction. In practical terms, when investors anticipate large upside volatility, they are unwilling to sell upside call stock options unless they receive a large premium. Option buyers will be willing to pay such high premiums only if similarly anticipating a large upside move. The resulting aggregate of increases in upside stock option call prices raises the VIX just as does the aggregate growth in downside stock put option premiums that occurs when option buyers and sellers anticipate a likely sharp move to the downside. When the market is believed as likely to soar as to plummet, writing any option that will cost the writer in the event of a sudden large move in either direction may look equally risky. Hence high VIX readings mean investors see significant risk that the market will move sharply, whether downward or upward. The highest VIX readings occur when investors anticipate that huge moves in either direction are likely. Only when investors perceive neither significant downside risk nor significant upside potential will the VIX be low.

There are a number of VIX-based derivative instruments in existence, including:

  • VIX futures contracts, which began trading in 2004
  • Exchange-listed VIX options, which began trading in February 2006
  • VIX futures based exchange-traded notes and exchange-traded funds, such as:
  • S&P 500 VIX Short-Term Futures ETN (NYSE: VXX) and S&P 500 VIX Mid-Term Futures ETN (NYSE: VXZ) launched by Barclays iPath in February 2009.
  • S&P 500 VIX ETF (LSE: VIXS) launched by Source UK Services in June 2010.
  • VIX Short-Term Futures ETF (NYSE: VIXY) and VIX Mid-Term Futures ETF (NYSE: VIXM) launched by ProShares in January 2011.

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