VIX: Explained

Tuesday, October 07, 2008

What does the VIX really mean? The Chicago Board Options Exchange Volatility Index is a very useful indicator of market sentiment and can signal turning points. The VIX is an index measuring the expected level of volatility in the US stock market over the next 30 days. Generally, measurements below 25 represent calm and readings over 25 represent uncertainty and fear.

The VIX is quoted as a percentage roughly representing the maximum expected annualized movements of the S&P 500 over the next 30 days. So, when the VIX is at 20, it means that traders have priced one standard deviation of movement in the S&P 500 as a 20% move over the next year. This corresponds to a 5.77% maximum move over the next 30 days falling within a 68% likelihood.


------------------------- = % upside range over next 30 days (68% likelihood)
(12 months)^(1/2)

Current State of Fear

A VIX closing at 53 today indicates a 68% likelihood that 30 days from now we will be within 15.30% (+ or -) of today's prices. With 95% certainty, traders are only willing to claim that the market will be within 30.60% (+/-) of today. This essentially means traders are wrought with uncertainty.

Compare these levels of uncertainty to a VIX at 20 where traders have 95% confidence that the market will be within 11.55% (+/-) of the current prices. Yesterday's all-time high peak in the VIX at 58 indicates that traders only give a 68% likelihood of the market being within a 33.49% range (+/- 16.74%) in 30 days. Now, that's uncertainty when pricing options.


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