VIX is the stock market symbol for the Chicago Board Options Exchange (CBOE) Volatility Index®, which is a popular indicator of expected stock market volatility. It was introduced on January 19, 1993 as a way to show the expected level of price fluctuation in S&P 500 Index (NYSE: SPX) options over the next 12 months.
The index itself is not tradable or investable. Also, actual volatility is the level of price fluctuations observed in past data, while the VIX conveys expectations of future volatility, also known as implied volatility.
The VIX is used as a barometer for market uncertainty and typically exhibits an inverse relationship with the S&P 500. VIX readings greater than 30 are considered a sign of forthcoming higher volatility from greater uncertainty, risk and investor fear. Meanwhile, VIX values below 20 tend to signal more stable periods ahead for the markets.
When investors anticipate large swings in the market, they try to reduce their risk exposure by using options to ‘hedge’ their positions. Hedging is a form of insurance, which has an investor take the opposite position in a stock they hold, using options. Option premiums represent the perceived level of risk in the market – greater perceived risk means investors will pay more for ‘insurance’ in the form of options.
VIX measures the level of expected volatility of the S&P 500 index over the next 30 days, as implied by the bid/ask quotes on SPX options, and then annualizes it to reflect the upcoming 12-month period. This is accomplished by aggregating the weighted prices of S&P 500 Index puts and calls over a wide range of strike prices. More specifically, the prices used to calculate VIX Index values are midpoints of real-time bid/ask price quotations on SPX options.
Note that the original construct only took into consideration the implied volatility of eight separate S&P 100 put and call options. The index was updated by CBOE in 2003, to expand the VIX to the S&P 500, to better capture broad market sentiment. The VIX Index – also referred to as the fear index – is the premier gauge of future U.S. equity market volatility.
Source: YCharts
