VIX is the volatility index created by CBOE in 1993, measuring market expectations of short-term volatility through the prices of S&P 500 stock index options. It uses the Black-Scholes options pricing model to calculate implied volatilities and is expressed as an annual percentage. VIX is sometimes referred to as an “investor fear indicator,” but it only measures implied volatility, not sentiment. Professional options traders express VIX as a daily percentage to estimate market changes between closing and reopening.
VIX, created by the Chicago Board Options Exchange (CBOE) in 1993, is the volatility index. Measures market expectations of short-term volatility as reflected in the prices of S&P 500 stock index options.
Implied volatility is an estimate of how much a security’s price is likely to move over a given period of time. VIX is built using the Black-Scholes options pricing model to calculate implied volatilities for a set of stock index options. These are combined to create an overall measure of market expectations for near-term volatility. The index was originally constructed using the S&P 100 index, but in 2004 CBOE moved to the S&P 500 to capture a larger segment of the overall market. To ensure continuity, the older calculation continues to be published under the VXO name.
The Black-Scholes model assumes that market movements can be expressed as a normally distributed probability function, better known as a bell curve. Visually, VIX is a measure of the height and width of the curve; a low number implies a very pointed shape, while a high number implies a short and wide shape. Mathematically, it is expressed as an annual percentage. A VIX of 15, for example, means that the market expects a 15% price change in the next year.
Professional options traders often choose to express VIX and other implied volatilities as a daily percentage. As they continuously adjust their positions based on market conditions, the greatest risk to them is when the markets are closed and changes cannot be made. Calculated as a daily percentage, VIX provides an estimate of how much the market might change between closing and reopening. The daily score can be approximated by dividing the yearly number by 16.
A great deal of market lore has arisen on VIX. It is sometimes referred to as an “investor fear indicator” because it has a tendency to rise sharply when markets are under stress. It is important to note, however, that the index does not measure sentiment, it only measures implied volatility. Since implied volatility is more significantly affected by changes in effective volatility, its increase during times of market stress is not due to investor sentiment, but due to increases in effective volatility.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
