CBOE Volatility Index VIX: What Does It Measure in Investing?

In other words, it should not be construed as a sign of an immediate market movement. NerdWallet, Inc. is an independent publisher and comparison service, not an investment advisor. Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only. NerdWallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances.

The reverse is true when the market advances—the index values, fear, and volatility decline. 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).

Investors, analysts, and portfolio managers look to the Cboe Volatility Index as a way to measure market stress before they make decisions. When VIX returns are higher, market participants are more likely to pursue investment strategies with lower risk. Thomas J Catalano is a CFP and Registered Investment Adviser with the https://www.day-trading.info/ state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning. Miranda Marquit has been covering personal finance, investing and business topics for almost 15 years.

A methodology was adopted that remains in effect and is also used for calculating various other variants of the volatility index. The first method is based on historical volatility, using statistical calculations on previous prices over a specific time period. This process involves computing various statistical numbers, https://www.topforexnews.org/ like mean (average), variance, and finally, the standard deviation on the historical price data sets. The VIX attempts to measure the magnitude of price movements of the S&P 500 (i.e., its volatility). The more dramatic the price swings are in the index, the higher the level of volatility, and vice versa.

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Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. 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.

The IAI is constructed by analyzing which topics generate the most reader interest at a given time and comparing that with actual events in the financial markets. 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. The VIX has paved the way for using volatility as a tradable asset, albeit through derivative products. CBOE launched the first VIX-based exchange-traded futures contract in March 2004, followed by the launch of VIX options in February 2006.

1. 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.
2. Instead, the VIX looks at expectations of future volatility, also known as implied volatility.
3. 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.
4. This process involves computing various statistical numbers, like mean (average), variance, and finally, the standard deviation on the historical price data sets.

Following the popularity of the VIX, the CBOE now offers several other variants for measuring broad market volatility. 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). 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. Only SPX options are considered whose expiry period lies within more than 23 days and less than 37 days. Although the VIX revealed high levels of investor anxiety, the Investopedia Anxiety Index (IAI) remained neutral.

How Can an Investor Trade the VIX?

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Market professionals refer to this as “implied volatility”—implied because the VIX tracks the options market, where traders make bets about the future performance of different securities and market indices, such as the S&P 500. Prices are weighted to gauge whether investors believe the https://www.forexbox.info/ S&P 500 index will be gaining ground or losing value over the near term. Technically speaking, the CBOE Volatility Index does not measure the same kind of volatility as most other indicators. Volatility is the level of price fluctuations that can be observed by looking at past data.

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At the time, the index only took into consideration the implied volatility of eight separate S&P 100 put and call options. After 2002, CBOE decided to expand the VIX to the S&P 500 to better capture the market sentiment. The VIX is considered a reflection of investor sentiment and has in the past been a leading indicator of a dip in the S&P 500, but that relationship may have changed in recent times. For instance, in the three months between Aug. 8, 2017, and Nov. 8, 2017, the VIX was up 19%—seemingly suggesting anxiety among market participants and implying that the S&P 500 should be on a downward trajectory. There are a range of different securities based on the CBOE Volatility Index that provide investors with exposure to the VIX.

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 index tracks the tendency of the S&P 500 to move away from and then revert to the mean. When the stock markets appear relatively calm but the VIX index spikes higher, professionals are betting that prices on the S&P 500—and thereby the stock market as a whole—may be moving higher or lower in the near term. When the VIX moves lower, investors may view this as a sign the index is reverting to the mean, with the period of greater volatility soon to end. 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. The CBOE Volatility Index (VIX) is a measure of expected price fluctuations in the S&P 500 Index options over the next 30 days.

Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Our estimates are based on past market performance, and past performance is not a guarantee of future performance. 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.

In addition to being an index to measure volatility, traders can also trade VIX futures, options, and ETFs to hedge or speculate on volatility changes in the index. VIX values are quoted in percentage points and are supposed to predict the stock price movement in the S&P 500 over the following 30 days. The VIX formula is calculated as the square root of the par variance swap rate over those first 30 days, also known as the risk-neutral expectation. This formula was developed by Vanderbilt University Professor Robert Whaley in 1993. The VIX is considered a reflection of investor sentiment, but one must remember that it is supposed to be a leading indicator.

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. 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.