VIX

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The CBOE Volatility Index (VIX)^[1] is a measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Simply put, the index measures the cost of using options as insurance against declines in the Standard & Poor's 500 Index.^[2]

Since its introduction in 1993, VIX has been considered by many to be an important barometer of investor sentiment and market volatility.^[3]^[4]^[5] It is often referred to as the "investor fear gauge." Dividing the value of the S&P 500 by the VIX ratio is said to give the confidence level in relation to the market. The higher the ratio, the higher the confidence.^[6]

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Futures on the CBOE's VIX were introduced on the CBOE Futures Exchange (CFE) in 2004, and are the most actively traded futures contract on the exchange.

Subsequently, in February 2006, options on the CBOE Volatility Index (VIX) began trading on the Chicago Board Options Exchange. The VIX options contract was the first product on market volatility to be listed on a Securities and Exchange Commission-regulated securities exchange.

On Oct. 20, 2008, the VIX rose to 70.33, its highest close since its introduction in 1993. To some experts, that suggested the wild ride in the stock market related to the credit crisis was far from over.^[7]

The VIX topped 40 during four periods prior to the credit crisis of 2008:

1997 - Asian financial crisis
1998 - Long-Term Capital Management's collapse
2001 - Attacks on the U.S. and
2002 - The aftermath of WorldCom Inc.'s bankruptcy.^[8]

Background

In an article entitled "Fear and Greed in Global Asset Allocation," in the spring 2000 issue of The Journal of Investing, the VIX was characterized as "a good indicator of the level of fear or greed in U.S. and global capital markets." When investors are fearful, the article noted, the VIX level is "significantly higher than normal."^[9]

The original VIX index, introduced by CBOE in 1993, was constructed using the implied volatilities of eight different OEX option series so that, at any given time, it represented the implied volatility of a hypothetical at-the-money OEX option with exactly 30 days to expiration. In 2003, this construction changed. ^[10]; it still measures the market's expectation of 30-day volatility, but in a way that better conforms to more recent thinking and research among industry practitioners. The "new" VIX, then:

Is based on S&P 500 index option prices and "incorporates information from the volatility 'skew' by using a wider range of strike prices rather than just at-the-money series." (The original VIX used only at-the-money options.)
Uses a newly developed formula to derive expected volatility directly from the prices of a weighted strip of options. (The original VIX extracted implied volatility from an option-pricing model.)
Uses options on the S&P 500 Index, which is the primary U.S. stock market benchmark. (The original VIX was based on S&P 100 Index - OEX - options prices.)

Resources

The CBOE Futures Exchange offers a monthly newsletter Futures in Volatility that provides a VIX market summary and analysis by options expert Larry McMillan. Futures In Volatility