CBOE Volatility Index VIX: What Does It Measure in Investing?

The most significant words in that description are expected and the next 30 days. The predictive nature of the VIX makes it a measure of implied volatility, not one that is based on historical data or statistical analysis. The time period of the prediction also narrows the outlook to the near term. 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.

This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research. Our partners cannot pay us to guarantee favorable reviews of their products or services. Options and futures based on VIX products are available for trading on CBOE and CFE platforms, respectively. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources.

1. Traders making bets through options of such high beta stocks utilize the VIX volatility values in appropriate proportion to correctly price their options trades.
2. In other words, when the price of VIX is going up, the price of the S&P 500 is usually heading south.
3. Just like with stocks, you can buy low and sell high with volatility.
4. However, the S&P 500 was busy scaling all-time highs during that time frame.
5. During the time period mentioned above, despite some concerns about the market, the overall IAI actually moved lower.
6. If you’re interested in investing in a VIX ETF/ETN, we recommend that you speak with a financial professional first to make sure your investment strategy fits your needs.

VIX values below 20 generally correspond to stable, stress-free periods in the markets. The formula used by Cboe to calculate the price of VIX is rather complex, and the price of VIX is updated live during trading hours every 15 seconds. 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.

Extending Volatility to Market Level

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. https://www.wallstreetacademy.net/ Such VIX-linked instruments allow pure volatility exposure and have created a new asset class. The CBOE Volatility Index (VIX) is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX).

As a market maker, you sell a product, which grows in value if certain situations occur. So, if you’re sitting at your desk one day, and you start seeing more and more orders coming in for an option, you might think these traders know something you don’t, and the markets will make a big move soon. As the range of strike prices for puts and calls on the S&P 500 increases, it indicates that the investors placing the options trades are predicting some price movement up or down.

When investors trade options, they are essentially placing bets on where they think the price of a specific security will go. In many cases, large institutional investors will use options trading to hedge their current positions. So, if the big firms on Wall Street are anticipating an upswing or downswing in the broader market, they may try to hedge against that volatility by placing options trades. If many of the large investment firms are anticipating the same thing, there is usually a spike in options trading for the S&P 500.

How Does the CBOE Volatility Index (VIX) Work?

When stock prices are expected to make a big move up or down, investors typically purchase more options. For example, suppose the market has been falling for a few days. This would cause many investors to become protective of their stock positions. The Charles Schwab Corporation provides a full range of brokerage, banking and financial advisory services through its operating subsidiaries.

Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Our estimates are based on past market performance, and past performance is not a guarantee of future performance. Sentiment plays a big role in decision making for the stock markets, and to that extent, it could be a good idea to glance at the VIX.

How to Trade the VIX

Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.

It breaks down investor anxiety into three distinct categories—1. The VIX is considered a reflection of investor sentiment, but one must remember that it is supposed to be a leading indicator. In other words, it should not be construed as a sign of an immediate market movement. During its origin in 1993, VIX was calculated as a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options, when the derivatives market had limited activity and was in its growing stages. 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).

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If you’ve been following financial news, you may have heard the word “volatility” being thrown around a lot — and you may have heard a reference to a volatility measurement called the VIX. NerdWallet, Inc. is an independent publisher and comparison service, not an investment advisor. Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only. NerdWallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances.

Typically, the performance of the VIX index and the S&P 500 are inversely related to each other. In other words, when the price of VIX is going up, the price of the S&P 500 is usually heading south. Following the popularity of the VIX, the CBOE now offers several other variants for measuring broad market volatility. Examples include the CBOE Short-Term Volatility Index (VIX9D), which reflects the nine-day expected volatility of the S&P 500 Index; the CBOE S&P Month Volatility Index (VIX3M); and the CBOE S&P Month Volatility Index (VIX6M). Products based on other market indexes include the Nasdaq-100 Volatility Index (VXN); the CBOE DJIA Volatility Index (VXD); and the CBOE Russell 2000 Volatility Index (RVX). 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.

The VIX index uses the bid/ask prices of options trading for the S&P 500 index in order to gauge investor sentiment for the larger financial market. These higher prices also have another effect—they attract option sellers. Now, for example, suppose the level of uncertainty in the market increases, and options premiums are now higher. Traders who felt the volatility was too high and would soon fall would begin selling options. If more option sellers appear, implied volatility levels will likely begin to fall.