VIX Index shows the market's expectation of 30-day volatility and
commonly called CBOE (Chicago Board Options Exchange) Volatility index.
This volatility is calculated from both calls and puts and is a widely
used as a measure of market risk.
There are three variations of volatility indexes:
- the VIX - tracks the S&P
500;
- the VXN - tracks the
Nasdaq 100;
- the VXD - tracks the Dow
Jones Industrial Average (DJIA).
The VIX volatility index was introduced by the CBOE in 1993. The VIX
index is a weighted measure of the implied volatility of the S&P 500
at-the-money put and call options. VIX index is associated with
investors' panic. Investors believe that a high value of VIX translates
into a greater degree of market uncertainty, while a low value of VIX is
consistent with greater stability. For instance the VIX values greater
than 30 are associated with a large amount of volatility as a result of
investor fear. On the other hand values below 20 correspond to less
stressful times in the markets.
The VIX is calculated in real-time by the CBOE and is a weighted
current market price for all out-of-the-money calls and puts for the two
nearest expiration options. The VIX index estimates the implied
volatility of at-the-money S&P 500 index option, with 30 days to
expiration.
Often, the VIX is used to represent overall sentiment for equity
options. However, it often appears that the index volatility and equity
volatility are uncorrelated, simply because different dynamics drive
them. Particularly, the VIX index is limited to a period of 30-days,
while as a rule the most liquid equity options are in the range of 2 to
6 months to expiration. At the same time the volatility depends on the
market sector and it is usually higher in technology stocks and lower in
utility stocks. Furthermore, it is overly simplistic to use the VIX to
represent the volatility for all equity options.