VIX

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CBOE Volatility Index (VIX) 2004-2020. CBOE Volatlity Index, VIX.png
CBOE Volatility Index (VIX) 2004–2020.

VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options. It is calculated and disseminated on a real-time basis by the CBOE, and is often referred to as the fear index or fear gauge.

Contents

The VIX traces its origin to the financial economics research of Menachem Brenner and Dan Galai. In a series of papers beginning in 1989, Brenner and Galai proposed the creation of a series of volatility indices, beginning with an index on stock market volatility, and moving to interest rate and foreign exchange rate volatility. [1] [2] [ full citation needed ]

In their papers, Brenner and Galai proposed, "[the] volatility index, to be named 'Sigma Index', would be updated frequently and used as the underlying asset for futures and options. ... A volatility index would play the same role as the market index plays for options and futures on the index." [3] In 1992, the CBOE hired consultant Bob Whaley to calculate values for stock market volatility based on this theoretical work. [4]

The resulting VIX index formulation provides a measure of market volatility on which expectations of further stock market volatility in the near future might be based. The current VIX index value quotes the expected annualized change in the S&P 500 index over the following 30 days, as computed from options-based theory and current options-market data.

To summarize, VIX is a volatility index derived from S&P 500 options for the 30 days following the measurement date, [5] with the price of each option representing the market's expectation of 30-day forward-looking volatility. [5] [6] The resulting VIX index formulation provides a measure of expected market volatility on which expectations of further stock market volatility in the near future might be based. [6]

Like conventional indexes, the VIX Index calculation employs rules for selecting component options and a formula to calculate index values. [6] [7] Unlike other market products, VIX cannot be bought or sold directly. [8] Instead, VIX is traded and exchanged via derivative contract, derived ETFs, and ETNs which most commonly track VIX futures indexes. [9]

In addition to VIX, CBOE uses the same methodology to compute the following related products: [6] [7]

CBOE also calculates the Nasdaq-100 Volatility Index (VXNSM), CBOE DJIA Volatility Index (VXDSM) and the CBOE Russell 2000 Volatility Index (RVXSM). [6] There is even a VIX on VIX (VVIX) which is a volatility of volatility measure in that it represents the expected volatility of the 30-day forward price of the CBOE Volatility Index (the VIX). [10]

Specifications

The concept of computing implied volatility or an implied volatility index dates back to the publication of the Black and Scholes' 1973 paper, "The Pricing of Options and Corporate Liabilities," published in the Journal of Political Economy, which introduced the seminal Black–Scholes model for valuing options. [11] Just as a bond's implied yield to maturity can be computed by equating a bond's market price to its valuation formula, an option-implied volatility of a financial or physical asset can be computed by equating the asset option's market price to its valuation formula. [12] In the case of VIX, the option prices used are the S&P 500 index option prices. [13] [14]

The VIX takes as inputs the market prices of the call and put options on the S&P 500 index for near-term options with more than 23 days until expiration, next-term options with less than 37 days until expiration, and risk-free U.S. treasury bill interest rates. Options are ignored if their bid prices are zero or where their strike prices are outside the level where two consecutive bid prices are zero. [6] [ page needed ] The goal is to estimate the implied volatility of S&P 500 index options at an average expiration of 30 days. [15]

Monthly mean of VIX volatility index, 2004-2019 Monthly mean of VIX volatility index.png
Monthly mean of VIX volatility index, 2004-2019

Given that it is possible to create a hedging position equivalent to a variance swap using only vanilla puts and calls (also called "static replication"), [16] the VIX can also be seen as the square root of the impled volatility of a variance swap [17] - and not that of a volatility swap, volatility being the square root of variance, or standard deviation.

The VIX is the square root of the risk-neutral expectation of the S&P 500 variance over the next 30 calendar days and is quoted as an annualized standard deviation. [18]

The VIX is calculated and disseminated in real-time by the Chicago Board Options Exchange.[ citation needed ] On March 26, 2004, trading in futures on the VIX began on CBOE Futures Exchange (CFE).[ citation needed ]

On February 24, 2006, it became possible to trade options on the VIX.[ citation needed ] Several exchange-traded funds hold mixtures of VIX futures that attempt to enable stock-like trading in those futures. The correlation between these ETFs and the actual VIX index is very poor, especially when the VIX is moving. [19]

VIX Formula

The VIX is the 30-day expected volatility of the SP500 index, more precisely the square root of a 30-day expected realized variance of the index. It is calculated as a weighted average of out-of-the-money call and put options on the S&P 500:

where is the number of average days in a month (30 days), is the risk-free rate, is the 30-day forward price on the S&P 500, and and are prices for puts and calls with strike and 30 days to maturity. [6] [20]

History

The following is a timeline of key events in the history of the VIX Index:[ according to whom? ]

Interpretation

Performance of VIX (left) compared to past volatility (right) as 30-day volatility predictors, for the period of Jan 1990-Sep 2009. Volatility is measured as the standard deviation of S&P500 one-day returns over a month's period. The blue lines indicate linear regressions, resulting in the correlation coefficients r shown. Note that VIX has virtually the same predictive power as past volatility, insofar as the shown correlation coefficients are nearly identical. Vix.png
Performance of VIX (left) compared to past volatility (right) as 30-day volatility predictors, for the period of Jan 1990-Sep 2009. Volatility is measured as the standard deviation of S&P500 one-day returns over a month's period. The blue lines indicate linear regressions, resulting in the correlation coefficients r shown. Note that VIX has virtually the same predictive power as past volatility, insofar as the shown correlation coefficients are nearly identical.

VIX is sometimes criticized as a prediction of future volatility. Instead it is described as a measure of the current price of index options.[ according to whom? ][ citation needed ]

Critics claim that, despite a sophisticated formulation, the predictive power of most volatility forecasting models is similar to that of plain-vanilla measures, such as simple past volatility. [34] [35] [36] However, other works have countered that these critiques failed to correctly implement the more complicated models. [37]

Some practitioners and portfolio managers have questioned the depth of our understanding of the fundamental concept of volatility, itself. For example, Daniel Goldstein and Nassim Taleb famously titled one of their research articles, We Don't Quite Know What We are Talking About When We Talk About Volatility. [38] Relatedly,[ verification needed ] Emanuel Derman has expressed disillusion with empirical models that are unsupported by theory.[ clarification needed ][ citation needed ] [39] [ page needed ] He argues that, while "theories are attempts to uncover the hidden principles underpinning the world around us... [we should remember that] models are metaphors—analogies that describe one thing relative to another."[ page needed ]

Michael Harris, the trader, programmer, price pattern theorist, and author, has argued that VIX just tracks the inverse of price and has no predictive power. [40] [41] [ better source needed ]

According to some,[ who? ] VIX should have predictive power as long as the prices computed by the Black-Scholes equation are valid assumptions about the volatility predicted for the future lead time (the remaining time to maturity).[ citation needed ] Robert J. Shiller has argued that it would be circular reasoning to consider VIX to be proof of Black-Scholes, because they both express the same implied volatility, and has found that calculating VIX retrospectively in 1929 did not predict the surpassing volatility of the Great Depression—suggesting that in the case of anomalous conditions, VIX cannot even weakly predict future severe events. [42]

An academic study from the University of Texas at Austin and Ohio State University examined potential methods of VIX manipulation. [43] On February 12, 2018, a letter was sent to the Commodity Futures Trading Commission and Securities and Exchange Commission by a law firm representing an anonymous whistleblower alleging manipulation of the VIX. [44]

Volatility of volatility

In 2012, the CBOE introduced the "VVIX index" (also referred to as "vol of vol"), a measure of the VIX's expected volatility. [45] VVIX is calculated using the same methodology as VIX, except the inputs are market prices for VIX options instead of stock market options. [10]

The VIX can be thought of as the velocity of investor fear. The VVIX can be thought of as the acceleration of investor fear.

Other Volatility indexes in the world

Tradable:

VSTOXX

Deribit BTCDVOL

Brazil Volatility Index [46]

See also

Related Research Articles

The Black–Scholes or Black–Scholes–Merton model is a mathematical model for the dynamics of a financial market containing derivative investment instruments. From the parabolic partial differential equation in the model, known as the Black–Scholes equation, one can deduce the Black–Scholes formula, which gives a theoretical estimate of the price of European-style options and shows that the option has a unique price given the risk of the security and its expected return. The equation and model are named after economists Fischer Black and Myron Scholes. Robert C. Merton, who first wrote an academic paper on the subject, is sometimes also credited.

In finance, a futures contract is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The asset transacted is usually a commodity or financial instrument. The predetermined price of the contract is known as the forward price or delivery price. The specified time in the future when delivery and payment occur is known as the delivery date. Because it derives its value from the value of the underlying asset, a futures contract is a derivative.

In financial mathematics, the implied volatility (IV) of an option contract is that value of the volatility of the underlying instrument which, when input in an option pricing model, will return a theoretical value equal to the price of said option. A non-option financial instrument that has embedded optionality, such as an interest rate cap, can also have an implied volatility. Implied volatility, a forward-looking and subjective measure, differs from historical volatility because the latter is calculated from known past returns of a security. To understand where implied volatility stands in terms of the underlying, implied volatility rank is used to understand its implied volatility from a one-year high and low IV.

A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, gambles, many types of over-the-counter and derivative products, and futures contracts.

An exchange-traded fund (ETF) is a type of investment fund that is also an exchange-traded product, i.e., it is traded on stock exchanges. ETFs own financial assets such as stocks, bonds, currencies, debts, futures contracts, and/or commodities such as gold bars. The list of assets that each ETF owns, as well as their weightings, is posted on the website of the issuer daily, or quarterly in the case of active non-transparent ETFs. Many ETFs provide some level of diversification compared to owning an individual stock.

Volatility risk is the risk of an adverse change of price, due to changes in the volatility of a factor affecting that price. It usually applies to derivative instruments, and their portfolios, where the volatility of the underlying asset is a major influencer of option prices. It is also relevant to portfolios of basic assets, and to foreign currency trading.

Greed and fear refer to two opposing emotional states theorized as factors causing the unpredictability and volatility of the stock market, and irrational market behavior inconsistent with the efficient-market hypothesis. Greed and fear relate to an old Wall Street saying: "financial markets are driven by two powerful emotions – greed and fear."

<span class="mw-page-title-main">Chicago Board Options Exchange</span> American exchange

The Chicago Board Options Exchange (CBOE), located at 433 West Van Buren Street in Chicago, is the largest U.S. options exchange with an annual trading volume of around 1.27 billion at the end of 2014. CBOE offers options on over 2,200 companies, 22 stock indices, and 140 exchange-traded funds (ETFs).

The S&P 100 Index is a stock market index of United States stocks maintained by Standard & Poor's.

In finance, correlation trading is a strategy in which the investor gets exposure to the average correlation of an index.

<span class="mw-page-title-main">Covered option</span> Stock options trading strategy

A covered option is a financial transaction in which the holder of securities sells a type of financial options contract known as a "call" or a "put" against stock that they own or are shorting. The seller of a covered option receives compensation, or "premium", for this transaction, which can limit losses; however, the act of selling a covered option also limits their profit potential to the upside. One covered option is sold for every hundred shares the seller wishes to cover.

The CBOE S&P 500 BuyWrite Index is a benchmark index designed to show the hypothetical performance of a portfolio that engages in a buy-write strategy using S&P 500 index call options.

In finance, an option is a contract which conveys to its owner, the holder, the right, but not the obligation, to buy or sell a specific quantity of an underlying asset or instrument at a specified strike price on or before a specified date, depending on the style of the option. Options are typically acquired by purchase, as a form of compensation, or as part of a complex financial transaction. Thus, they are also a form of asset and have a valuation that may depend on a complex relationship between underlying asset price, time until expiration, market volatility, the risk-free rate of interest, and the strike price of the option. Options may be traded between private parties in over-the-counter (OTC) transactions, or they may be exchange-traded in live, public markets in the form of standardized contracts.

In finance, a stock market index future is a cash-settled futures contract on the value of a particular stock market index. The turnover for the global market in exchange-traded equity index futures is notionally valued, for 2008, by the Bank for International Settlements at US$130 trillion.

An inverse exchange-traded fund is an exchange-traded fund (ETF), traded on a public stock market, which is designed to perform as the inverse of whatever index or benchmark it is designed to track. These funds work by using short selling, trading derivatives such as futures contracts, and other leveraged investment techniques.

<span class="mw-page-title-main">IVX</span> Intraday, VIX-like volatility index for US securities and exchange traded instruments

IVX is a volatility index providing an intraday, VIX-like measure for any of US securities and exchange traded instruments. IVX is the abbreviation of Implied Volatility Index and is a popular measure of the implied volatility of each individual stock. IVX represents the cost level of the options for a particular security and comparing to its historical levels one can see whether IVX is high or low and thus whether options are more expensive or cheaper. IVX values can be compared for the stocks within one industry to find names which significantly differ from what is observed in overall sector.

Menachem Brenner is a professor of finance and a Bank and Financial Analysts Faculty Fellow at New York University Stern School of Business.

The S&P/ASX200 VIX (A-VIX) is a financial market product that participants trade based on the market price of the implied volatility in the underlying Australian equity index.

<span class="mw-page-title-main">Cboe Global Markets</span> American company

Cboe Global Markets is an American company that owns the Chicago Board Options Exchange and the stock exchange operator BATS Global Markets.

<span class="mw-page-title-main">Antonio Mele</span> Italian economist

Antonio Mele is an Italian economist.

References

  1. ↑ Brenner, Menachem; Galai, Dan (July–August 1989). "New Financial Instruments for Hedging Changes in Volatility" (PDF). Financial Analysts Journal. 45 (4): 61–65. doi:10.2469/faj.v45.n4.61.[ full citation needed ]
  2. ↑ Brenner, Menachem; Galai, Dan (Fall 1993). "Hedging Volatility in Foreign Currencies" (PDF). The Journal of Derivatives. Unknown volume (unknown issue): unknown page nos.[ full citation needed ]
  3. 1 2 3 Brenner, Menachem; Galai, Dan (1989). "New Financial Instruments for Hedging Changes in Volatility" . Financial Analysts Journal. 45 (4): 61–65. doi:10.2469/faj.v45.n4.61. ISSN   0015-198X. JSTOR   4479241.
  4. ↑ Bob Pisani (29 March 2020). "Father of Wall Street's 'fear gauge' sees wild volatility continuing until coronavirus cases peak". CNBC . Retrieved 29 March 2020.
  5. 1 2 Kuepper, Justin. "CBOE Volatility Index (VIX) Definition". Investopedia. Retrieved 2020-04-10.
  6. 1 2 3 4 5 6 7 8 "Whitepaper: Cboe Volatility Index" (PDF). CBOE.com. 2019. Retrieved 26 February 2020.[ page needed ]
  7. 1 2 "How Does the Cboe's VIX® Index Work? | Six Figure Investing". sixfigureinvesting.com. 10 July 2014. Retrieved 2020-04-10.
  8. ↑ Iachini, Michael. "VIX ETFs: The Facts and Risks". Schwab Brokerage. Retrieved 2020-04-10.
  9. ↑ Reiff, Nathan. "How to Use a VIX ETF in Your Portfolio". Investopedia. Retrieved 2020-04-10.
  10. 1 2 "Cboe Index Dashboard". www.cboe.com. Retrieved 2020-09-02.
  11. ↑ Black, Fischer; Scholes, Myron (1973). "The Pricing of Options and Corporate Liabilities". Journal of Political Economy. 81 (3): 637–654. doi:10.1086/260062. ISSN   0022-3808. JSTOR   1831029. S2CID   154552078.
  12. ↑ Nickolas, Steven. "Implied Volatility". Investopedia. Retrieved 2020-08-18.
  13. ↑ "VIX Options". www.cboe.com. Retrieved 2020-08-18.
  14. ↑ "Olymp Trade promo code". Honestdigitalreview.com. 24 August 2019. Retrieved 2020-07-22.
  15. ↑ "Cboe Tradable Products". www.cboe.com.
  16. ↑ "Just what you need to know about Variance Swaps" (PDF). May 2005.
  17. ↑ Kanas, Angelos (2013-06-01). "The risk-return relation and VIX: evidence from the S&P 500". Empirical Economics. 44 (3): 1291–1314. doi:10.1007/s00181-012-0639-4. ISSN   1435-8921.
  18. ↑ "White Paper Cboe Volatility Index" (PDF). Retrieved 15 March 2024.
  19. ↑ Conway, Brendan (17 June 2014). "No, Your ETF Doesn't Track the VIX Volatility Index—and Here are the Numbers". Barrons.com. Retrieved 26 February 2020.
  20. ↑ Papanicolaou, Andrew (5 April 2016). "Identifying Links Between the S&P500 and VIX Derivatives". Institute for Pure & Applied Mathematics. UCLA. Retrieved 10 April 2020.
  21. ↑ "Volatility" (PDF). people.stern.nyu.edu. Retrieved 2020-02-26.
  22. ↑ "IFR report" (PDF). people.stern.nyu.edu. 1992. Retrieved 2020-02-26.
  23. ↑ "Derivatives on market volatility" (PDF). rewconsulting.files.wordpress.com. 2012. Retrieved 2020-02-26.
  24. ↑ Mehta, Salil (July 2015). "Volatility in motion" (blog). Statistical Ideas. Retrieved 26 February 2020– via Statisticalideas.blogspot.com.
  25. 1 2 "History". www.cboe.com. Retrieved 2021-11-20.
  26. ↑ "Update: 3-Volatility index below 30 for 1st time since Sept". Reuters. 2009-05-19. Retrieved 2021-11-20.
  27. ↑ Yun Li (March 16, 2020). "Wall Street's fear gauge closes at highest level ever, surpassing even financial crisis peak". MSNBC. Retrieved March 17, 2020.
  28. ↑ "CBOE Volatility Index". MarketWatch. February 7, 2018. Archived from the original on February 7, 2018. Retrieved August 23, 2020.
  29. ↑ Yakob Peterseil (March 9, 2020). "VIX Spikes to Highest Since 2008 in Manic Monday Trading". Bloomburg. Retrieved March 9, 2020.
  30. ↑ Pete Evans (March 9, 2020). "'This is basically panic selling': Stock markets plunge as coronavirus fear spreads". CBC. Retrieved March 9, 2020.
  31. ↑ Nicholas Jasinski (March 12, 2020). "The VIX Fear Gauge Is Soaring. It's Unlikely to Come Down Anytime Soon". Barron's. Retrieved March 12, 2020.
  32. ↑ Li, Yun (March 16, 2020). "Wall Street's fear gauge closes at highest level ever, surpassing even financial crisis peak". cnbc.com. Retrieved March 19, 2020.
  33. ↑ Jonathan Stempel. (17 May 2021). "S&P Dow Jones Indices is fined by SEC over U.S. 'volatility' crash". Yahoo Finance website Retrieved 18 May 2021.
  34. ↑ Cumby, R.; Figlewski, S.; Hasbrouck, J. (1993). "Forecasting Volatility and Correlations with EGARCH models". Journal of Derivatives. 1 (2): 51–63. doi:10.3905/jod.1993.407877. S2CID   154028452.
  35. ↑ Jorion, P. (1995). "Predicting Volatility in Foreign Exchange Market". Journal of Finance . 50 (2): 507–528. doi:10.1111/j.1540-6261.1995.tb04793.x. JSTOR   2329417.
  36. ↑ Adhikari, B.; Hilliard, J. (2014). "The VIX, VXO and realised volatility: a test of lagged and contemporaneous relationships". International Journal of Financial Markets and Derivatives. 3 (3): 222–240. doi:10.1504/IJFMD.2014.059637.
  37. ↑ Andersen, Torben G.; Bollerslev, Tim (1998). "Answering the Skeptics: Yes, Standard Volatility Models Do Provide Accurate Forecasts". International Economic Review. 39 (4): 885–905. doi:10.2307/2527343. JSTOR   2527343.
  38. ↑ Goldstein, Daniel G.; Taleb, Nassim Nicholas (28 March 2007). "We Don't Quite Know What We are Talking About When We Talk About Volatility". Journal of Portfolio Management. 33 (4). doi:10.3905/jpm.2007.690609. S2CID   153535794. SSRN   970480.
  39. ↑ Derman, Emanuel (2011). Models Behaving Badly: Why Confusing Illusion With Reality Can Lead to Disaster, on Wall Street and in Life. New York, NY: Simon and Schuster. pp. unknown page nos. ISBN   9781439165010 . Retrieved 25 February 2020.
  40. ↑ Harris, Michael (21 August 2012). "On the Zero Predictive Capacity of VIX—Price Action Lab Blog" (self-published blog). PriceActionLab.com. Retrieved 25 February 2020.
  41. ↑ Harris, Michael (25 August 2012). "Further Analytical Evidence that VIX Just Tracks the Inverse of Price" (self-published blog). PriceActionLab.com. Retrieved 25 February 2020.
  42. ↑ Shiller, Robert (30 March 2011). "Econ 252-11: Financial Markets [Lecture 17—Options Markets]". New Haven, CT: Yale University. Archived from the original (college course content) on 22 September 2016. Retrieved 26 February 2020– via OYC.Yale.edu.
  43. ↑ Griffin, John M.; Shams, Amin (May 23, 2017). "Manipulation in the VIX?" . SSRN.com. doi:10.2139/ssrn.2972979. S2CID   157586475. SSRN   2972979 . Retrieved 25 February 2020.
  44. ↑ Cornish, Chloe (13 February 2018). "Anonymous 'Whistleblower' Claims 'Rampant Manipulation' of Vix Index" . Financial Times . Retrieved 26 February 2020– via FT.com.
  45. ↑ "Double the Fun with CBOE's VVIX Index" (PDF). CBOE.com. March 13, 2012. Retrieved November 19, 2019.
  46. ↑ "Cboe Brazil ETF Volatility Index".

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