Specifically, the expected volatility implied by SPX option prices tends to trade at a premium relative to subsequent realized volatility in the S&P 500 Index. Market participants have used VIX futures and options to capitalize on this general difference between expected (implied) and realized (actual) volatility, and other types of volatility arbitrage strategies. 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 does your will executor need to be bonded uncertain, the market is. That much is understood by most investors, but what exactly is volatility and how is it measured for the overall stock market? You may have seen references to something called the VIX, an index that measures volatility, during times of extreme financial stress.
The CBOE Volatility Index (VIX) is a measure of expected price fluctuations in the S&P 500 Index options over the next 30 days. The VIX, often referred to as the “fear index,” is calculated in real time by the Chicago Board Options Exchange (CBOE). 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. 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.
S&P Dow Jones Indices: A Practitioner’s Guide to Reading VIX
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. 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. 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.
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. 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. Experts understand what the VIX is telling them through the lens of mean reversion.
The VIX is merely a suggestion, and it’s been proven to be wrong about the future direction of markets nearly as often as it’s been right. 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.
- Market participants have used VIX futures and options to capitalize on this general difference between expected (implied) and realized (actual) volatility, and other types of volatility arbitrage strategies.
- 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.
- Technically speaking, the CBOE Volatility Index does not measure the same kind of volatility as most other indicators.
- Miranda is completing her MBA and lives in Idaho, where she enjoys spending time with her son playing board games, travel and the outdoors.
Long/Short Volatility
In August 2024, the VIX jumped above 60, a level not seen since the market meltdown in the initial stages of COVID-19 in March 2020, as worries grow about a possible recession. 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. Volatility is one of the primary factors that affect stock and index options’ prices and premiums.
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. As an investor, if you see the VIX rising it could be a sign of volatility ahead. You might consider shifting some of your portfolio to assets thought to be less risky, like bonds or money market funds.
It should be noted that these are rough guidelines ⏤ unexpected events can throw a wrench into markets and a low VIX level today could be followed by a period of extreme volatility if circumstances change. Although the VIX revealed high levels of investor anxiety, the Investopedia Anxiety Index (IAI) remained neutral. 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. Generally speaking, if the VIX index is at 12 or lower, the market is considered to be in a period of low volatility. On the other hand, abnormally high volatility is often seen as anything that is above 20.
Instead, the VIX looks at expectations of future volatility, also known as implied volatility. Times of greater uncertainty (more expected future volatility) result in higher VIX values, while less anxious times correspond with lower values. The VIX, formally known as the Chicago Board Options Exchange (CBOE) Volatility Index, measures how much volatility professional investors think the S&P 500 index will experience over the next 30 days. 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. 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).
How Does the CBOE Volatility Index (VIX) Work?
It then started using a wider set of options based become a windows network engineer 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. Alternatively, VIX options may provide similar means to position a portfolio for potential increases or decreases in anticipated volatility. The VIX index tracks the tendency of the S&P 500 to move away from and then revert to the mean.
Beta represents how much a particular stock price can move with respect to the move in a broader market index. 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. 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. Sentiment plays a big role in decision making for the stock markets, and to that extent, it could be a good idea to glance at the VIX. However, the index is far from perfect, and investors should consider how much weight they want to peg on it. However, the VIX can be traded through futures contracts, exchange-traded funds (ETFs), and exchange-traded notes (ETNs) that own these futures contracts.
VIX vs. S&P 500 Price
Volatility is a statistical measure based on how much an asset’s price moves in either direction and is often used to measure the riskiness of an asset or security. CFE lists nine standard (monthly) VIX futures contracts, and six weekly expirations in VIX futures. As such, there is a wide variety of potential calendar spreading opportunities depending on expectations for implied volatility. Technically speaking, the CBOE Volatility Index does not measure the same kind of volatility as most other indicators. Volatility is Trading sugar the level of price fluctuations that can be observed by looking at past data.