What is the VIX Index?
The VIX Index (CBOE Volatility Index) is an index that uses real-time, mid-quote values of S&P 500 Index call and put options to provide a measure of constant, 30-day projected volatility of the U.S. stock market.
It is one of the most well-known indicators of volatility on a worldwide scale, extensively covered by financial media and constantly monitored by a wide range of market players as a daily market indicator.
The index was developed by Professor Robert E. Whaley of Duke University, whom the Chicago Board Options Exchange (CBOE) commissioned. Providing a quantitative measure of market risk and investors’ sentiment, the index is valuable in trading and investment.
How to calculate the VIX index?
Indices are calculated by summing up the prices of the stocks that comprise them. The index values are calculated using a formula that governs the selection of stocks included in the index.
The index measures the S&P 500 Index’s predicted 30-day volatility. It is composed of short and long-term puts and calls (with expirations of fewer than 37 days and longer than 23 days) instead of stocks, whose price reflects market expectations of future volatility.
The VIX formula is the square root of the par variance swap rate over the first 30 days, commonly known as the risk-neutral expectation. VIX Index values are expressed in percentage points and annualized to cover the next twelve months.
As with conventional indices, the VIX Index is calculated using rules to select the options that make up the index and a formula to determine the index values.
For an in-depth understanding of the formula, its components are described in the White Paper.
What is the current VIX Index?
The VIX Index is currently at 37.55. (as of 10:18 AM EST, January 24, 2022). The ratio was 17.67 last month, compared to 33.09 a year ago.
How to interpret VIX Index values?
The VIX Index is widely known as the “Fear Index” because it measures the level of fear or stress in the stock market, using the S&P 500 index as a proxy for the entire market.
As such, the VIX reacts accordingly during times of significant market turmoil. The index rose gradually as the market neared the height of the late 1990s technological bubble, then leveled off during the stable growth period of 2003-2007, soared during the 2008 economic crisis and in the second half of 2011, and rose again when the Covid-19 pandemic stroke markets in 2020.
The higher the VIX, the greater the level of fear and uncertainty in the market, with levels above 30 indicating extreme uncertainty. In contrast, VIX values below 20 typically correspond to times of market stability.
VIX index activity falls into two categories when the index spikes or when it swells:
- VIX spikes frequently signify a short-term market panic, signaling a buying opportunity for investors.
- On the other hand, VIX swells (slow upward movements as the market recovers) often depicts a coming correction.
High VIX
On October 20, 2008, the index reached its all-time high of 79,130, corresponding to the infamous global financial crash.
Market uncertainty is indicated by VIX levels more than 30. As of January 2022, the index is hovering around 33, indicating a high-volatility market.
Average VIX
A VIX of 13-19 is considered average, and the ensuing volatility over the following 30 days is predicted to be normal when the index is at this range.
Low VIX
The historical lowest close for the VIX Index was 9.14 on November 3, 2017. At that time, the U.S. stock markets were recoding record highs and healthy global economic expansion.
Low VIX values indicate a stable, healthy, growing market with a low volatility climate.
How to use the VIX Index?
Volatility is a valuable metric for investors since it allows them to assess the market’s current state. It also presents prospects for investment. Volatility investments can be used to hedge risk because volatility is generally correlated with low stock market performance.
However, it can also represent a rapidly growing market. Hence, volatility investments can be utilized to speculate in either an up or downward trend.
VIX values are available for trading through derivatives such as futures, options, and exchange-traded products.
Historical evidence demonstrates a substantial negative association between volatility and stock market performance, and these VIX-linked instruments are extensively utilized to diversify portfolios.
What are the limitations of the VIX Index?
The VIX Index is a near-term indicator. Inferring anything beyond a short-term timeframe has the potential to be exceedingly misleading. For example, at the onset of the pandemic, in early 2020, the index was hanging around 13, which is relatively low and hence represented an optimistic market outlook. However, it surged to 66 in March 2020, indicating the polar opposite.
Although the VIX is certainly useful for investors, as it has a significant negative correlation with the S&P 500 (rising when the stock market falls and falling when the stock market rises), tracking its daily swings in the hopes of avoiding market turbulence is a rather pointless strategy that provides no real portfolio protection.
Is the VIX Index a reliable indicator?
Yes, the VIX index is globally regarded as one of the most reliabstle volatility and market sentiment indicators, with multiple research studies to back it up. The correlation pattern between this index and the stock market behavior has historically persisted during bull and bear cycles: The VIX surges at times of market instability and decreases when the market is bullish.
In summary, the VIX Index is a financial metric that helps investors identify trend peaks, troughs, and lulls and provides insight into the sentiment of key market participants.
This is useful for preparing for trend changes and for investors deciding on the optimal hedging strategy for their portfolios. It is, however, not perfect, and investors must always exercise caution in their approach.
See our list of other important financial indicators.
