Monday, June 22, 2009
Tracking & Learning About VIX
VIX is an often quoted indicator, especially over the past 9 months, to say something about the volatility in the market place. A higher trending VIX implies a trend towards risk aversion, or higher fear ratings on all assets. Plenty of players are now looking at VIX as the most immediate indicator for sensing 'fear' in the market place. Those trying to get a forward reading will go as far as tracking the trades in VIX options. Last week's selloff in developed markets coincided with a sharp jump in VIX and a rapid run up in VIX call options, somehow that has dropped down again, as noted by Bespoke. As a rule of thumb, anytime the VIX appears to be headed north of 40, its time to exit all stocks, ... still just a rule of thumb.
After settling nicely below the 30 level for about a week, the S&P 500 Volatility Index (VIX) jumped back above 30 earlier this week. Today, however, the VIX has dropped significantly below 30 once again down to 28.36. Earlier in the day it was down even more, but even as the market has moved back to flat, the VIX is still down quite a bit. As long as the VIX continues its downtrend, fears in the market are subsiding.
10 Things You Should Know About VIX by Bill Luby
Q: What is the VIX?
A: In brief, the VIX is the ticker symbol for the volatility index that the Chicago Board Options Exchange uses to calculate the implied volatility of options on the S&P 500 index (SPX) for the next 30 days.
Q: How is the VIX calculated?
A: The CBOE utilizes a wide variety of strike prices for SPX puts and calls to calculate the VIX. In order to arrive at a 30 day implied volatility value, the calculation blends options expiring on two different dates, with the result being an interpolated implied volatility number. For the record, the CBOE does not use the Black-Scholes option pricing model. Details of the VIX calculations are available from the CBOE in their VIX white paper.
Q: Why should I care about the VIX?
A: There are several reasons to pay attention to the VIX. Most investors who monitor the VIX do so because it provides important information about investor sentiment that can be helpful in evaluating potential market turning points. A smaller group of investors use VIX options and VIX futures to hedge their portfolios; and an even smaller bunch use those same options and futures to speculate on the future direction of the market.
Q: What is the history of the VIX?
A: The VIX was originally launched in 1993, with a slightly different calculation than the one that is currently employed. The ‘original VIX’ (which is still tracked under the ticker VXO) differs from the current VIX in two main respects: it is based on the S&P 100 (OEX) instead of the S&P 500; and it targets at the money options instead of the broad range of strikes utilized by the VIX. The current VIX was reformulated on September 22, 2003, at which time the original VIX was assigned the VXO ticker. VIX futures began trading on March 26, 2004 and VIX options followed on February 24, 2006.
Q: Why is the VIX sometimes called the “fear index”?
A: The CBOE has actively encouraged the use of the VIX as a tool for measuring investor fear in their marketing of the VIX and VIX-related products. As the CBOE puts it, “since volatility often signifies financial turmoil, [the] VIX is often referred to as the ‘investor fear gauge’”. The media has been quick to latch onto the headline value of the VIX as a fear indicator and has helped to reinforce the relationship between the VIX and investor fear.
Q: How does the VIX differ from other measures of volatility?
A: The VIX is the most widely known of a number of volatility indices. The CBOE alone recognizes nine volatility indices, the most popular of which are the VIX, the VXO, the VXN (for the NASDAQ-100 index), and the RVX (for the Russell 2000 small cap index). In addition to volatility indices for US equities, there are volatility indices for foreign equities (VDAX, VSTOXX, VSMI, VX1, MVX, VAEX, VBEL, VCAC) as well as lesser known volatility indices for other asset classes such as currencies.
Q: What are normal, high and low readings for the VIX?
A: This question is more complicated than it sounds, because some people focus on absolute VIX numbers and some people focus on relative VIX numbers. On an absolute basis, looking at a VIX as reformulated in 2003, but using data reverse engineered going back to 1990, the mean is a little bit over 19, the high is just below 90 and the low is just below 10. Just for fun, using the VXO (original VIX formulation), it is possible to calculate that the VXO peaked at about on Black Monday, October 19, 1987.
Q: Can I trade the VIX?
A: At this time it is not possible to trade the cash or spot VIX directly. The only way to take a position on the VIX is through the use of VIX options and futures. On 1/30/09, Barclays Capital launched two new VIX ETNs that are based on VIX futures: VXX, which targets VIX futures with 1 month to maturity; and VXZ, which targets 5 months to maturity.
Q: How can the VIX be used as a hedge?
A: The VIX is appropriate as a hedging tool because it has a strong negative correlation to the SPX – and is generally about four times more volatile. For this reason, portfolio managers often find that buying of out of the money calls on the VIX to be a relatively inexpensive way to hedge long portfolio positions. Similar hedges can be constructed using VIX futures.
Q: How do investors use the VIX to time the market?
A: This is a subject for a much larger space, but in general, the VIX tends to trend in the very short-term, mean-revert over the short to intermediate term, and move in cycles over a long-term time frame. The devil, of course, is in the details.
p/s photo: Cristine Reyes