CBOE Volatility Index VIX: What Does It Measure in Investing?
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. 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. As a rule of thumb, VIX values greater than 30 are generally linked to large volatility resulting from increased uncertainty, risk, and investors’ fear. VIX values below 20 generally correspond to stable, stress-free periods in the markets. There are a range of different securities based on the CBOE Volatility Index that provide investors with exposure to the VIX.
- The CBOE Volatility Index—also known as the VIX—is a primary gauge of stock market volatility.
- Because the S&P 500 includes so many large companies across several different market sectors, it is generally viewed as a good indication of how the U.S. stock market is performing overall.
- Astute investors tend to buy options when the VIX is relatively low and put premiums are cheap.
- The more dramatic the price swings are in the index, the higher the level of volatility, and vice versa.
- Before investing in any VIX exchange-traded products, you should understand some of the issues that can come with them.
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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 VIX is calculated using average weighted https://www.currency-trading.org/ real-time call and put prices across the S&P 500 index with an expiration date of between 23 and 37 days out. Because the S&P 500 index represents about 80% of the value of U.S. stocks, the VIX is used as a gauge of uncertainty in the overall U.S. stock market.
Higher options prices across the overall stock market indicate that investors expect heightened volatility. It’s possible to buy futures contracts or exchange-traded funds (ETFs) and exchange-traded notes that own these futures contracts in an effort to mirror the index. Because the volatility index tends to rise when the S&P 500 falls, investors might do so if they’re bearish on the stock market.
ETNs in particular can be less liquid and more difficult to trade as well as may carry higher fees. The second method, which the VIX uses, involves inferring its value as implied by options prices. Options are derivative instruments whose price depends upon the probability of a particular stock’s current price moving enough to reach a particular level (called the strike price or exercise price). Generally speaking, if the VIX index is at 12 or lower, the market is considered to be in a period of low volatility.
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Instead, investors can take a position in VIX through futures or options contracts, or through VIX-based exchange traded products (ETPs). Such VIX-linked instruments allow pure volatility exposure and have created a new asset class. The Chicago Board Options Exchange Volatility Index, or VIX, is an index that gauges the volatility investors expect in the U.S. stock market. Rather, it’s a leading indicator that measures https://www.topforexnews.org/ the level of stock market volatility expected by investors. In this article, we’ll delve into what the VIX measures, how it’s calculated, and whether you should use it in your investment decisions. 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.
Although the index can provide helpful information, investor sentiment isn’t always correct. In fact, the VIX tends to overestimate market volatility by about 4% to 5% on average, according to Fidelity. The CBOE Volatility Index—also known as the VIX—is a primary gauge of stock market volatility. The VIX volatility index offers insight into how financial professionals are feeling about near-term market conditions.
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In finance, mean reversion is a key principle that suggests asset prices generally remain close to their long-term averages. If prices gain a great deal very quickly, or fall very far, very rapidly, the principle of mean reversion suggests they should snap back to their long-term average before long. Market professionals rely on a wide variety of data sources and tools to stay on top of the market. The VIX is one the main indicators for understanding when the market is possibly headed for a big move up or down or when it may be ready to quiet down after a period of volatility. Before investing in any VIX exchange-traded products, you should understand some of the issues that can come with them. Certain VIX-based ETNs and ETFs have less liquidity than you’d expect from more familiar exchange traded securities.
Alternatively, you could adjust your asset allocation to cash in recent gains and set aside funds during a down market. 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. VIX values are calculated using the CBOE-traded standard SPX options, which expire on the third Friday of each month, and the weekly SPX options, which expire on all other Fridays. Only SPX options are considered whose expiry period lies within more than 23 days and less than 37 days. Before purchasing a security tied to an index like the VIX, it’s important to understand all of your options so that you can make educated decisions about your investment choices.
It then started using a wider set of options based 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. The VIX was the first benchmark index introduced by CCOE https://www.forexbox.info/ to measure the market’s expectation of future volatility. The VIX index tracks the tendency of the S&P 500 to move away from and then revert to the mean. 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.
Or they may take a position in a VIX-linked product for portfolio diversification or as a hedging strategy. Just keep in mind that with investing, there’s no way to predict future stock market performance or time the market. 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. Prices are weighted to gauge whether investors believe the S&P 500 index will be gaining ground or losing value over the near term. 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.
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Active traders who employ their own trading strategies and advanced algorithms use VIX values to price the derivatives, which are based on high beta stocks. Beta represents how much a particular stock price can move with respect to the move in a broader market index. For instance, a stock having a beta of +1.5 indicates that it is theoretically 50% more volatile than the market. Traders making bets through options of such high beta stocks utilize the VIX volatility values in appropriate proportion to correctly price their options trades.
On the other hand, abnormally high volatility is often seen as anything that is above 20. When you see the VIX above 30, that’s sometimes viewed as an indication that markets are very unsettled. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation. Options and futures based on VIX products are available for trading on CBOE and CFE platforms, respectively.
Greater volatility means that an index or security is seeing bigger price changes—higher or lower—over shorter periods of time. The first method is based on historical volatility, using statistical calculations on previous prices over a specific time period. This process involves computing various statistical numbers, like mean (average), variance, and finally, the standard deviation on the historical price data sets.
To spare you the math headache involved with calculating the price, let’s look instead at the data used to calculate it. The VIX index is specifically measuring expected volatility for another index, the S&P 500. True to its name, the S&P 500 index is composed of 500 of the largest publicly traded companies in the U.S.