CBOE Volatility Index VIX Chart

Understanding how the VIX works and what it’s saying can help short-term traders tweak their portfolios and get a feel for where the market is headed. Volatility is one of the primary factors that affect stock and index options’ prices and premiums. As the VIX is the most widely watched measure of broad market volatility, it has a substantial impact on option prices or premiums. A higher VIX means higher prices for options (i.e., more expensive option premiums) while a lower VIX means lower option prices or cheaper premiums. It tends to rise during times of market stress, making it an effective hedging tool for active traders. When its level gets to 20 or higher, expectations are that volatility will be above normal over the coming weeks.

Does the Level of the VIX Affect Option Premiums and Prices?

That’s why most everyday investors are best served by regularly investing in diversified, low-cost index funds and letting dollar-cost averaging smooth out any pricing swings over the long term. One of the most popular and accessible of these is the ProShares VIX Short-Term Futures ETF (VIXY), which is based on VIX futures contracts with a 30-day maturity. Some exchange-traded securities let you speculate on implied volatility up to six months in the future, such as the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ), which invests in VIX futures with four- to seven-month maturities. Large institutional investors hedge their portfolios using S&P 500 options to position themselves as winners whether the market goes up or down, and the VIX index follows these trades to gauge market volatility.

How Does the CBOE Volatility Index (VIX) Work?

It’s important to note here that while volatility can have negative connotations, like greater risk, more stress, deeper uncertainty or bigger market declines, volatility itself is a neutral term. Greater volatility means that an index or security is seeing bigger price changes—higher or lower—over shorter periods of time. Downside risk can be adequately hedged by buying put options, the price of which depends on spreadex forex broker review market volatility.

For instance, a stock having a beta of +1.5 indicates that it is theoretically 50% more volatile than the market. Traders making bets through options of such high beta stocks utilize the VIX volatility values in appropriate proportion to correctly price their options trades. Active traders who employ their own trading strategies and advanced algorithms use VIX values to price the derivatives, which are based on high beta stocks. Beta represents how much a particular stock price can move with respect to the move in a broader market index. All such qualifying options should have valid nonzero bid and ask prices that represent the market perception of which options’ strike prices will be hit by the underlying stocks during the remaining time to expiry. Since option prices are available in the open market, they can be used to derive the volatility of the underlying security.

On the other hand, during times when the VIX is falling, indicating the possibility of more stability to come in the stock market, it might make more sense to focus on individual stocks or other riskier assets that might fare well during times of growth. During its origin in 1993, VIX was calculated as a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options, when the derivatives market had limited activity and was in its growing stages. The second method, which the VIX uses, involves inferring its value as implied by options prices. Options are derivative instruments whose price depends upon the probability of a particular stock’s current price moving enough to reach a particular level (called the strike price or exercise price).

1. The index is more commonly known by its ticker symbol and is often referred to simply as “the VIX.” It was created by the CBOE Options Exchange and is maintained by CBOE Global Markets.
2. Therefore, this compensation may impact how, where and in what order products appear within listing categories, except where prohibited by law for our mortgage, home equity and other home lending products.
3. That much is understood by most investors, but what exactly is volatility and how is it measured for the overall stock market?
4. On the other hand, abnormally high volatility is often seen as anything that is above 20.
5. It is an important index in the world of trading and investment because it provides a quantifiable measure of market risk and investors’ sentiments.

About Volatility S&P 500 Index

Perhaps the most straightforward way to invest in the VIX is with exchange-traded funds (ETFs) and exchange-traded notes (ETNs) based on VIX futures. As exchange-traded products, you can buy and sell these securities like stocks, greatly simplifying your VIX investing strategy. Such VIX-linked instruments allow pure volatility exposure and have created a new asset class. It then started using a wider set of options based on the broader S&P 500 Index, an expansion that allows for a more accurate view of investors’ expectations of future market volatility. A methodology was adopted that remains in effect and is also used for calculating various other variants of the volatility index. There are a range of different securities based on the CBOE Volatility Index that provide investors with exposure to the VIX.

Cboe Volatility Index (VIX): What is it and how is it measured?

For people watching the VIX index, it’s understood that the S&P 500 stands in for “the stock market” or “the market” as a whole. When the VIX index moves higher, this reflects the fact that professional investors are responding to more price volatility in the S&P 500 in particular and markets more generally. When the VIX declines, investors are betting there will be smaller price moves up or down in the S&P 500, which implies calmer markets and less uncertainty. The CBOE Volatility Index (VIX) is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX).

Investing in the VIX directly is not possible, but you can purchase ETFs that track the index as a way to speculate on future changes in the VIX or as a tool for hedging. This isn’t something that will make sense for most investors who are working to meet a long-term goal such as saving for retirement. Examples include the CBOE Short-Term Volatility Index (VIX9D), which reflects the nine-day expected volatility of the S&P 500 Index; the CBOE S&P Month Volatility Index (VIX3M); and the CBOE S&P Month Volatility Index (VIX6M). Products based on other market indexes include the Nasdaq-100 Volatility Index (VXN); the CBOE DJIA Volatility Index (VXD); and the CBOE Russell 2000 Volatility Index (RVX). Bankrate’s AdvisorMatch can connect you to a CFP® professional to help you achieve your financial goals. As the derivatives markets matured, 10 years later, in 2003, the CBOE teamed up with Goldman Sachs and updated the methodology to calculate VIX differently.

Because it is derived from the prices of SPX index options with near-term expiration dates, it generates a 30-day forward projection of volatility. Volatility, or how fast prices change, is often seen as a way to gauge market sentiment, and in particular the degree of fear among market participants. The VIX, which was first introduced in 1993, is sometimes called the “fear index” because it can be used by traders and investors to gauge market sentiment and see how fearful, or uncertain, the market is.

Since the possibility of such price moves happening within the given time frame is represented by the volatility factor, various option pricing methods (like the Black-Scholes model) include volatility as an integral input parameter. The first method is based on historical volatility, using statistical calculations on previous prices over a specific time period. This process involves computing https://forexanalytics.info/ various statistical numbers, like mean (average), variance, and finally, the standard deviation on the historical price data sets. You might consider shifting some of your portfolio to assets thought to be less risky, like bonds or money market funds.

Extending Volatility to Market Level

Miranda Marquit has been covering personal finance, investing and business topics for almost 15 years. She has contributed to numerous outlets, including NPR, Marketwatch, U.S. News & World Report and HuffPost. Miranda is completing her MBA and lives in Idaho, where she enjoys spending time with her son playing board games, travel and the outdoors.

Such volatility, as implied by or inferred from market prices, is called forward-looking implied volatility (IV). Before investing in any VIX exchange-traded products, you should understand some of the issues that can come with them. Certain VIX-based ETNs and ETFs have less liquidity than you’d expect from more familiar exchange traded securities. ETNs in particular can be less liquid and more difficult to trade as well as may carry higher fees. However, the VIX can be traded through futures contracts, exchange-traded funds (ETFs), and exchange-traded notes (ETNs) that own these futures contracts. VIX values are calculated using the CBOE-traded standard SPX options, which expire on the third Friday of each month, and the weekly SPX options, which expire on all other Fridays.