Understanding Cboe Volatility Index (VIX)

280 views | Francis Azuka | April 1, 2021

VIX Index is the popular name for the Chicago Board Options Exchange’s CBOE Index which is a known measure of the stock market’s projection of volatility based on S&P 500 index options. It predicts the volatility of the market over the coming 30 days. This tool is crucial for investors as they use it to measure the degree of risk or stress in the market while planning to invest in the market.

How does the VIX Index work?

The VIX is calculated by using the prices of SPX index. It is then expressed in terms of percentage. An increasing VIX value indicates falling S&P 500 and vice versa. Usually, when VIX is high there is a trend of buying stocks and vice versa.

How volatility is measured?

There are two methods for measuring its volatility. First method uses statistical calculations such as mean, variance, and standard deviation over a certain interval of time. The value obtained as a result of these  calculations provides a measure of risk or volatility. The volatility can also be measured directly by using spreadsheets in Microsoft excel. The standard deviation method does not provide accurate projection because it is based upon past trends and future assumptions. In this way, by referring to the past and recent scheme, the future is predicted on that basis.

The other method that can be used for projecting VIX volatility involves inferring its values as implied by option prices. The price of options depends upon the current price moving enough to reach a certain level. It is imperative to keep in mind that none of the above methods is perfect as both have their own deviations from projections and merits and demerits.

Extending volatility to market level:

In the world of investments, volatility is an indicator of rise or fall a stock price undertakes. So, it represents the degree of risk associated with a particular market. The standard quantitative measure for volatility helps in keeping track of the risk associated with moving prices. This is the first benchmark introduced by Cboe to guage the market’s expectations.

Calculations of VIX Index values:

These values are calculated by using the Cboe-traded standard SPX options that end on third Friday of each month. By assessing the prices of multiple SPX puts and calls over a variety of prices, it estimates the expected volatility of the S&P 500 index.

Hoe to trade the VIX?

Although the products deviate from projections, VIX has provided a way to use volatility as a tradable asset. Cboe also provides some other variants to broadly measure the volatility of a market other than this standard VIX index. The VIX index, like all other indexes cannot be bought directly. Rather, the investors take positions through options contracts. So summing up the discussion, we can conclude that VIX index measures the fluctuations in the price of a security or index. This is a useful tool for investors to get projections about future trends.

 

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