Volatility Index
Meaning of the Volatility Index
The volatility Index, abbreviated as VIX, indicates expected volatility in the stock market and is based on the options of the SandP 500 Index over a 30-day forward period. This index was created by the Chicago Board Options Exchange and is also known as the CBOE Volatility Index.
How does the volatility index work?
The term volatility in the case of the stock market
refers to a statistical measure of the degree to which the prices of stock market products change over some time. The VIX calculated the expected volatility based on the prices of the call and put options of the SandP 500 shares. The weighted average of the
prices of the put and call options of the SandP 500 is added to obtain a number of the strike prices. The midpoints of the
bid and ask prices of the options are taken into account in calculating the index.
Two types of SandP options are considered for VIX, namely those which expire on the third Friday of each month and those which expire every Friday. The prices of the weighted average options are then calculated to reach the value of the index according to CBEE.
When the market shows an uptrend, less volatility arises as investor confidence increases and they tend to buy more calls than puts. On the other hand, when the market is going down it creates panic among market participants as more puts are bought instead of calls resulting in more volatility in the market. Market. Therefore, in a bull market the VIX is usually lower due to less volatility and in a bear market
the VIX is higher due to market turbulence. There is therefore an inverse relationship between the market trend and the index.
Criticism
Analysts sometimes criticize the use of VIX to predict future market volatility. It is criticized on the following subjects.
The strength with which VIX predicts volatility is equivalent to that of simple methods such as simple past volatility.
The only thing the VIX tracks are reversed in price, and there is a lack of predictive power in VIX.
VIX only represents implied volatility
because it cannot predict volatility under abnormal conditions in the future.
VIX has also been charged with being manipulated by an unknown informant.
Uses
The Volatility Index (VIX) can be used by investors to decide when to trade in the market. The user can analyze the evolution of the volatility index and make the most of it as follows:
The index allows knowing the expected fluctuations of the market. When the VIX starts showing a significant rise it means that there will be a major shift in the market and now is the best time to act, when the index is high it indicates a decline in the stock market.
The volatility index also has an impact on the prices of
puts and calls, and both increase. When the index is high, the higher premiums should be taken into account when deciding whether to hold or buy options.
Trading can also be done on futures and VIX options. Many investment opportunities are available for the same.
Conclusion
The VIX is used to determine the movements of the SandP 500 stocks. There is an inverse relationship between the market and the index. When this relationship does not follow for a specified period, the current direction of stocks would be unsustainable for a short period.
