Wednesday, May 20, 2009

In the News: The VIX Index

Lately there has been a lot of discussion about the VIX in the financial media (see Barron’s).

The financial crisis has morphed VIX into Wall Street's one-stop indicator that everyone references to see if investors are bullish or bearish toward stocks. When VIX rises, it's interpreted as a sign that investors are afraid to own stocks. When VIX declines, it means they're confident about stocks.

The VIX is the ticker symbol for the Chicago Board Options Volatility Index. It is an estimate of the  volatility in the S&P 500 index options and, accordingly, is sometimes called the fear index. The index is positively related to volatility under the assumption that it is more costly to insure against risk with options when the market is volatile. It is not correlated with the market, because a market can be highly volatile in both the upward and downward direction.

Data on the VIX and the chart below can be found at Yahoo Finance. As can be seen, there was a dramatic run up in the VIX at the end of last year. Since then it has been returning to previous levels. The VIX is calculated in real time, representing the expected volatility of puts and calls over the next 30 days. A value of 28 indicates that the expected annualized change in the S&P 500 over the next month is 28 percent. The one month movement of clip_image002[4]represents a change of one standard deviation over the next month. Consequently, given a VIX of 28  there is a 68 percent probability that movement in the S&P 500 will be within plus or minus 8.08 percent.

More information on the VIX is available at the CBOE


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