VIX

VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Referred to by some as the fear index, it represents one measure of the market's expectation of volatility over the next 30 day period.

History

Here is a timeline of some key events in the history of the VIX Index:

* 1993 - The VIX Index was introduced in a paper by Professor Robert E. Whaley of Duke University.
* 2003 - Revised, more robust methodology for the VIX Index was introduced. The underlying index is changed from the CBOE S&P 100 Index (OEX) to the CBOE S&P 500 Index (SPX).
* 2004 - On March 26, 2004, the first-ever trading in futures on the VIX Index began on the CBOE Futures Exchange (CFE).
* 2006 - VIX options were launched in February 2006.

In 2004 and 2006, VIX Futures and VIX Options were each named Most Innovative Index Product (respectively) at the Super Bowl of Indexing Conference.[1]

Specifications

The VIX is calculated and disseminated in real-time by the CBOE. It is a weighted blend of prices for a range of options on the S&P 500 index. The formula uses a kernel-smoothed estimator that takes as inputs the current market prices for all out-of-the-money calls and puts for the front month and second month expirations.[2] The goal is to estimate the implied volatility of a synthetic, at-the-money option on the S&P 500 index, with 30 days to expiration.

Interpretation

The VIX is quoted in terms of percentage points and translates, roughly, to the expected movement in the S&P 500 index over the next 30-day period, on an annualized basis. For example, if the VIX is at 15, this represents an expected annual change of 15%; thus one can infer that the index option markets expect the S&P 500 to move up or down \frac{15%}{\sqrt{12\ months}} = 4.33% over the next 30-day period. That is, if, for example, the S&P 500 is currently at 100, index options are priced with the assumption of a 68% likelihood (one standard deviation) that the 30-day change in the S&P 500 will be within 4.3 points up or down.

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.

Note that because the VIX is quoted as a percentage rather than a dollar amount, there are no highly liquid instruments that will realize the VIX's "return", such as ETFs can do for regular indices. Nonetheless, VIX-based derivative instruments do exist, including:

* VIX futures contracts, which began trading in 2004, and
* exchange-listed VIX options, which began trading in February 2006.

Criticism

Often, when commentators discuss the option markets, the VIX is used to represent overall sentiment for equity options. However, to many practitioners, the relationship of the VIX to individual equity options can be easily overstated. It often appears that different dynamics drive the volatility of index options compared to that of equity options, and the two can often be uncorrelated. In particular, the VIX is limited to a 30-day period, while for most non-index equity options, the most liquidity is usually found in the 2 to 6-month maturities. In addition, volatility is often a function of market sector. For instance, volatility is usually assumed to be high in technology stocks, and low in utility stocks. Using a single number such as the VIX to represent the volatility for all equity options is usually overly simplistic.