Vix (volatility index)

The Chicago Board Options Exchange (CBOE) Volatility index (Vix for short) reflects how volatile traders expect the market to be over the coming year.

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.

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.

Recommended

Margin call
Glossary

Margin call

When an investor borrows to bet on markets, they put down a deposit known as “margin”.
2 Apr 2021
Resource curse
Glossary

Resource curse

The term “resource curse” refers to the observation that countries with abundant natural resources also tend to be less economically developed than th…
14 Jan 2021
Balance of payments
Glossary

Balance of payments

The balance of payments refers to the accounts that sum up a country's financial position relative to other countries.
8 Jan 2021
Yield-curve control
Glossary

Yield-curve control

Yield-curve control is when a central bank aims to control long-term interest rates by pledging to buy (or sell) as many long-term bonds as needed to …
25 Dec 2020

Most Popular

How are my cryptocurrency gains taxed in the UK?
Bitcoin & crypto

How are my cryptocurrency gains taxed in the UK?

Many investors in cryptocurrencies have made big gains. But once you take profits – or even buy one cryptocurrency with another – you could be liable…
18 May 2021
US stocks look expensive – here’s what to own instead
Investment strategy

US stocks look expensive – here’s what to own instead

Right now, US stocks are among the most expensive in the world. So if you want a decent return on your investments, you should look into diversifying …
17 May 2021
How will Joe Biden’s capital gains tax rise affect crypto prices?
Bitcoin & crypto

How will Joe Biden’s capital gains tax rise affect crypto prices?

The US president wants to increase capital gains tax – and that’s going to hit a lot of American cryptocurrency speculators. Saloni Sardana looks at h…
14 May 2021