The CBOE S&P 500 Volatility Index (VIX) is known as the “Fear Index” because it is such a helpful gauge to measure how worried traders are that the S&P 500 might suddenly drop within the next 30 days.
When the CBOE S&P 500 Volatility Index starts moving higher, it is telling you that traders are getting nervous. When the VIX starts moving lower, it is telling you that traders are gaining confidence.
The CBOE S&P 500 Volatility Index is a real-time index that represents the market’s expectation of future volatility of the stock market.
Its formal name is the Chicago Board of Options Exchange Market Volatility Index (VIX).
Technically speaking, volatility measures the standard deviation of historical market prices. Financial mumbo jumbo aside, volatility simply refers to how much price fluctuates over time.
A volatility index is a measure of a particular market’s likelihood of making sudden, unexpected price movements, or its relative instability.
The Chicago Board of Options Exchange Market Volatility Index is a measure of implied volatility, based on the prices of a basket of S&P 500 Index options with 30 days to expiration.
The VIX is known by other names like “Fear Gauge” or “Fear Index“.
It is the most well-known volatility index on the market and is commonly used by stock and options traders to gauge the market’s anxiety level.
What is the CBOE Volatility Index?
The CBOE Volatility Index, or VIX, is the most recognized tool to trade financial market volatility.
It measures the 30-day expected or forward-looking volatility of the U.S. stock market based on the S&P 500 options.
Put simply, it is a mathematical measure of how much the market thinks the S&P 500 Index option, or SPX, will fluctuate over the next 12 months, based upon an analysis of the difference between current SPX put and call option prices.
Although the CBOE Volatility Index isn’t expressed as a percentage, it should be understood as one.
For example, a CBOE Volatility Index of 30 translates to the implied volatility of 30% on the SPX.
This means that the index has a 66.7% probability (or within one standard deviation) of trading within a range 30% higher OR lower than its current level, over the next year.
If the S&P 500 is currently trading at 3,000, VIX is “implying” that over the next 12 months, its price will fluctuate between 2,100 and 3,900 (30% below and above 3,000).
And the probability of S&P 500 trading within this specific range is 66.7% (or one standard deviation).
The VIX rises when put option buying increases, and falls when call buying activity is more robust.
A call option is an option contract in which the holder (buyer) has the right (but not the obligation) to buy a specified quantity of a stock at a specified price within a fixed period of time.
A put option is an option contract in which the holder (buyer) has the right (but not the obligation) to sell a specified quantity of a stock at a specified price within a fixed period of time.
What is Volatility?
Volatility measures the frequency and magnitude of price movements, both up and down, that a financial instrument experiences over a certain period of time.
The more dramatic the price swings in that instrument, the higher the level of volatility.
Volatility can be measured using actual historical price changes (realized volatility) or it can be a measure of expected future volatility that is implied by options prices.
The VIX Index is a measure of expected future volatility.
How is the VIX Calculated?
The VIX Index estimates expected volatility by aggregating the weighted prices of S&P 500 Index (SPXSM) puts and calls over a wide range of strike prices.
Specifically, the prices used to calculate VIX Index values are midpoints of real-time SPX option bid/ask price quotations.
How is VIX Used?
The VIX Index is used as a barometer for market uncertainty, providing market participants and observers with a measure of the constant, 30-day expected volatility of the broad U.S. stock market.
A rising VIX indicates that traders expect the S&P 500 Index to become more volatile. If VIX gives a value of greater than 30 then the market is seen as volatile, while under 20 is believed to be calm. The higher the VIX, the higher the fear
For contrarians, high readings are bullish.
A falling VIX indicates that traders in the options market expect the S&P 500 Index to trade more quietly. The lower the VIX, the lower the fear.
This indicates a more complacent market. For contrarians, low sustained readings are bearish.
When and Where does the VIX trade?
The VIX Index is not directly tradable, but the VIX methodology provides a formula for replicating volatility exposure with a portfolio of SPX options, an innovation that led to the creation of tradable VIX futures and options.
The VIX Index is calculated and disseminated overnight, providing market participants with real-time volatility information whenever news breaks.
The Chicago Board Options Exchange rolled out the VIX in 1993 during regular trading hours between 9:30 a.m. and 4:15 p.m. ET.
In 2016, the CBOE activated the index outside of U.S. trading hours and between 3 a.m. and 9:15 a.m. ET.
Monthly and weekly expirations in VIX options are available and trade during U.S. regular trading hours and during a limited global trading hours session.
There are several ETFs (Exchange Traded Funds) that mirror the VIX such as VXX, VIXY, and VIIX.