The Chicago Board Options Exchange (CBOE) Volatility index (Vix for short) was created in 1992 by finance professor Robert Whaley, based on the academic work of Menachem Brenner and Dan Galai.
The Vix is calculated using the weighted average prices of various options on the S&P 500 index. Options give buyers the right (but not the obligation, hence the name) to buy ("call") or sell ("put") the index at a certain price. So they can be used to bet on the market moving in one direction, or to "hedge" a portfolio against short-term adverse moves.
One factor affecting option prices is the expected level of volatility (the more volatile the market, the more likely it is that the option will end up "in the money" ie, worth something). So the Vix reflects how volatile traders expect the market to be over the coming year broadly speaking, above 30 represents high volatility, while below 20 suggests calm.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Some argue that the Vix works well as a contrarian indicator a low Vix indicates that traders expect calm conditions to continue, and are thus overly complacent, suggesting that stocks should fall (leading to the nickname, "the fear gauge"). However, most studies have shown the Vix to be a coincident indicator (ie, it shows what's happening right now) rather than any use as a forecasting tool, contrarian or otherwise.
Equally, the Vix can rise alongside stocks sharp moves can happen to the upside as well as the downside. One problem with trying to trade the Vix is that exchange-traded products that are "long" the Vix tend to lose money over time, because of the cost of "rolling over" the underlying futures contracts on which they are built. This is one reason why shorting the Vix has become so popular. However, this carries its own risks, which will only become ever more important as less experienced traders pile in.
-
8 of the best houses for sale for around £1 millionThis week: the best houses for sale for around £1 million – from a wing of a Grade II-listed Victorian manor house in Sunderland, to a brick-and-flint cottage in Cley next the Sea, Norfolk
-
Starling Bank to scrap 3.25% interest rate from popular current account within daysStarling is to remove the generous 3.25% it pays on current accounts from next week – what does this mean for customers and should you move?
