Last Updated on 20 April, 2023 by Samuelsson
If you have been watching some financial analysis on the major media channels like CNBC, Bloomberg, and CNN Money, you must have heard about the fear gauge or VIX index — an index used to track investors’ perceptions about the future direction of the market.
Although you may have heard about the VIX Index several times, there are a lot of things you may not know about it. We have created this definitive guide to explain all you need to know about the VIX index.
In this guide, you will learn:
- What VIX is
- How the VIX came about
- How VIX is calculated
- How to interpret the VIX
- How the VIX behaves
- The meaning of Backwardation and contango
- The different types of VIX indexes
- How to trade the VIX and strategies
- The securities that track the VIX
- Creating a synthetic VIX – VIXfix
- What IVX is
- How IVX is different from VIX
This article is long, so please have a look in the table of contents, in case what you want to know comes in the latter part of the article!
What Is The VIX?
VIX is the short form for volatility index, which is a financial benchmark fashioned in a way that makes it a real-time estimate of the expected volatility in the market. Formulated by the Chicago Board of Options Exchange (CBOE), the VIX is the ticker symbol of the CBOE volatility index, which is considered by most people as the first barometer of equity market volatility.
To be specific, the VIX Index is designed to provide an instantaneous measure of how much the market participants think the S&P 500 Index will move in either direction in the next 30 days from the time of each tick of the VIX Index. It is derived from the quoted prices of the S&P 500 Index options, so it measures implied volatility of the general market.
The “Fear Gauge”
Since it tracks investors sentiment, the VIX index is often referred to as the Fear gauge or Fear Index. Because it can help identify extreme emotions in the market, it can be an important contrarian sentiment indicator, indicating when there’s excessive optimism or anxiety in the market.
Several market players, such as institutional fund managers, financial analysts, retail traders, and investors, closely watch the VIX values as a way to estimate the level of fear, anxiety, stress, and risk in the market before making any investments decisions. Although the VIX is only a number and not a tradable security in itself, there are options and futures contracts, as well as exchange-traded funds and notes that are based on the VIX values.
To properly understand the VIX index, you need to understand what volatility is and how it is measured.
What Exactly Is Volatility?
In the financial market, volatility is a statistical metric that measures the degree of variation in the price of a financial asset observed over a period of time. Volatility tries to gauge the extent of price movement — either up or down — in an asset and how long it took for the move to occur. The bigger and faster the security’s price moves, the higher the degree of volatility while the smaller and slower the security moves, the less the degree of volatility.
How is Volatility Measured?
There could be said to exist two main approaches to measuring volatility:
- Use of historical prices over a specified time interval to calculate realized volatility, with the expectation that the same holds in the future
- Use of option prices to infer future volatility
The first approach entails calculating historical volatility (realized volatility) by computing statistical parameters, such as mean, variance, and ultimately, the standard deviation, using historical price data. The standard deviation thus calculated, represents a measure of volatility. But, as you can see, this is based on the assumption that history will repeat itself in the future, which may not always be the case. So, predicting future volatility based on past data may not be an accurate representation of future expectations in the market.
The second approach, which involves inferring the future value from options prices, tries to anticipate where the price may get to in the future based on the expectations investors have of the market. By using options prices, it takes into account the sentiments in the market, so it may be a better representation of future risk.
Measuring Future Volatility With Options
Options are derivatives whose prices are based on the probability of the underlying asset’s price getting beyond the agreed price level known as the exercise price or strike price. For instance, let’s say the present price of the Facebook stock is $185 per share, and there’s a put option on Facebook with $170 exercise price and two months expiry.
The probability of the price of Facebook dropping below the $170 level within the two months will determine the price of the put option. And this is dependent on the perceived volatility in the Facebook stock. Since option prices are already available in the open market, it is, therefore, possible to calculate the volatility in the stock from the option prices. This type of volatility is called implied volatility or forward-looking volatility.
Applying it to Indexes
Now, this can be applied on a sector-specific index to get an idea of the volatility in the entire sector. Similarly, extending this to a broad market index like the S&P Index will show the level of volatility in the general market, and this is exactly what the VIX Index does. With the VIX Index, you can have an idea of the expected market fluctuations in the next 30 days. Together with other related volatility indexes (which measure the volatility in other markets like bonds), you can easily compare the risks associated with different markets and securities.
In theory, an increasing VIX value should mean increased volatility in either direction — up or down — because call option premium can increase when investors are expecting a huge upside move, just as put option premium can rise when the general market expectation is for a significant decline. And, a low VIX value would imply that investors expect neither a huge upside potential nor a significant downside risk.
However, in real life, the VIX seems to increase when the broad market index (S&P 500 Index) is going down and decrease when the market is going up. So it actually tracks investors’ fear of downside risk — no wonder it is called the ‘Fear Gauge’.
Who Invented the VIX
For those who are not very interested in the technical aspects of VIX, we recommend you to jump here!
It was in 1987 when two professors of finance, Menachem Brenner and Dan Galai, started working on the idea of a volatility index in an academic paper that they would later publish in July 1989 in the Financial Analysts Journal.
They proposed the creation of certain volatility indices that would track volatility in the stock market, interest rate, and foreign exchange market. They called the stock market volatility index the ‘Sigma Index’ and explained that it would be updated frequently and used as an underlying asset for futures and options.
In 1992, the American Stock Exchange conducted a feasibility study of the proposed Sigma index, and the Chicago Board of Options Exchange contracted Bob Whaley to calculate values for a stock market volatility index based on the Sigma model. Whaley would use the data series in the S&P 100 Index options market to compute daily a volatility index levels from 1986 to 1992, marking the origin of the VIX.
On the 19th of January 1993, the CBOE held a press conference, announcing the launch of a real-time stock market volatility index, and the VIX was born. As at then, the formula for the VIX was based on the CBOE S&P 100 Index (OEX) prices. The index measures implied volatility calculated with 30-day S&P 100 Index at-the-money options, but the formula would later change, and the old index was renamed VXO.
Changes in Calculation and Launch
It was in 2003 that the CBOE introduced the new way of calculating the VIX index. The CBOE worked closely with Goldman Sachs to develop new computation methods, changing the underlying index from the CBOE S&P100 Index (OEX) to the CBOE S&P 500 Index (SPX). With this recalculation, the present VIX index data is different from the previous volatility index data, so the previous one was aptly renamed.
The VIX index itself is not tradable as it’s is just a number that shows the perceived future volatility in the market, but it didn’t take long before tradable securities that use the VIX Index as their underlying asset were created. On the 26th of March 2004, the first-ever futures contract based on the VIX Index was launched on the new, all-electronic CBOE Futures Exchange (CFE). VIX futures currently trade on several platforms in different parts of the world, including the XTB.
Options trading on the VIX index would commence in February 2006. And since then, other tradable VIX-linked products have been developed, including exchange-traded funds (ETFs) and exchange-traded notes (ETNs). Some examples include iPath Series B S&P 500 Short-term Futures ETN (VXX/VXXB), VelocityShares Daily Long VIX Short-term ETN (VIIX), and Proshare VIX Short-term Futures ETF (VIXY).
These VIX-linked products make it possible for trader, investors, and fund managers to trade pure volatility, thereby creating a new set of assets. The new asset class provides market players with new means of diversifying their portfolios since the VIX index often is negatively correlated to the market movements.
Apart from the standard VIX Index, the CBOE calculates several other variants of the broad market volatility index, including the VIX9Dsm, VIX3Msm, VIX6Msm, VXNsm, VXDsm, and RVXsm — more on them later.
Youtube video about: Volatility – Should You Buy Or Sell Stocks in Volatile Markets?
How Is VIX Calculated?
The CBOE, working with Goldman Sachs in 2003, changed the method of calculating the VIX Index to reflect a new way of measuring implied volatility, which is being used by financial experts and risk managers. They changed the underlying index for the new VIX Index to the S&P 500 Index — the broad index for the U.S. equity market — and calculated the implied volatility by aggregating the weighted prices of SPX put and call options over a wide range of strike prices.
The aim was to get an annualized expected volatility of S&P 500 Index options with an average expiration of 30 days. With this new script for formulating volatility exposure with a portfolio of SPX options, this new method has transformed the VIX Index from being a concept to a practical standard for hedging and trading volatility.
The shortest duration of the available options then were the monthly options. But in 2005, CBOE introduced weekly options on most of the indexes (including the S&P 500), equities, ETFs, and ETNs, and they became very popular with time. The SPX weekly options now account for about one-third of all SPX options traded on the exchange.
With the introduction of SPX weekly options, it became possible to calculate the VIX Index with series of SPX weekly options that precisely match the 30-day target period for implied volatility, which the VIX Index is meant to stand for. So, in 2014, the CBOE modified the VIX Index to use series of SPX weekly options. Only options with more than 23 days and less than 37 days to expiration are used to ensure that the VIX index is always reflected as an interpolation of two points along the SPX weekly options volatility structure.
The Step by Step process of VIX calculation
Just like stock indexes (the S&P 500 Index, for example) — which are calculated with the prices of their component stocks — have criteria for selecting the component stocks and how they’re weighted, the VIX Index also has rules that govern the selection of its components.
Being comprised of options whose prices reflect the market expectation of future volatility, the VIX Index has criteria for selecting the component options and a formula to directly derive its value from the whole set of prices of the selected options.
But instead of going into the formula and all the technical jargons involved, we’ll show you the steps involved and the logic behind them. And, here they are:
- Choosing the options to be included in the calculation
- Estimating the contribution of each option to the total variance of its expiration group and calculating the total variance for the near-term and next-term options
- Estimating the 30-day variance by interpolating the two variances according to their time of expiration
- Calculating the volatility as a standard deviation by taking the square root of the 30-day variance
- Getting the VIX value by multiplying the standard deviation (volatility) by 100
Step 1: Selecting the Options to Be Included
Basically, three factors determine the SPX options used in the calculation:
- Options premiums and their strike prices
- Time of expiration
- Risk-free interest rate
Options Premiums and Their Strike Prices
The bid and ask quotes of the weekly SPX options are the data used in calculating the VIX, and they include out-of-the-money SPX calls and out-of-the-money SPX puts centered around an at-the-money strike price. Only SPX options quoted with non-zero bid prices are used in the VIX Index calculation to eliminate the illiquid far out-of-money options which can distort the result with their extreme values.
The selection of strike prices go from at-the-money strike up (in the case of calls) and at-the-money strike down (in the case of puts) until it finds two consecutive zero-bid strike prices in each direction. After this, no other options are included.
It is important to note that only the S&P 500 Index options quotes from COBE are used, and as volatility rises and falls, the strike price range of options with non-zero bids tends to expand and contract. As a result, the number of options used in the VIX Index calculation may vary from month-to-month, day-to-day and possibly, even minute-to-minute.
Time of Expiration:
The target timeframe for the VIX Index is 30 days, and the time of expiration for the individual options is calculated precisely up to the minutes. The end of duration is when the settlement value is being decided — market open (8:30 am CT) on the day of settlement (normally third Friday of the month) for monthly SPX options and market close (3:00 pm) for weekly options.
Since the target time is 30 days, two consecutive expiration terms are used — the near-term and next-term. Near-term options are the options whose expirations are more than 23 days while the next-term options must have less than 37days expiration. Once the near-term options get to 23 days, they are no longer used. They are replaced with the next-term options so that the next in line of expiration becomes the new next-term options, and the rollover is done continuously all the time.
Risk-free Interest Rate
The bond-equivalent yield of the U.S. Treasury Bills that matures closest to the specific option term is the risk-free rate used in the calculation of the VIX Index. So the different option expiration terms may require different interest rates.
Step 2: Estimating the Contributions of Each Option
To determine the contribution of each option, you need to consider the option’s price, its strike price, and the average strike price increment of the neighboring strikes. Typically, at-the-money options contribute more to the final result, and the contributions decrease as you move further out-of-the-money.
Step 3: Estimating the 30-day Variance
This is done by interpolating the total variances of the two option terms. Each of the two variances is assigned a weight, according to how far the expiration is from the target 30-day mark — the farther the expiration is, the less the weight assigned. The sum of the weights should be 1.
Step 4: Calculating the Standard Deviation
After getting the 30-day variance, you need to get the standard deviation, which is the normal measure of volatility. To get this, simply find the square root of the 30-day variance.
Step 5: Getting the VIX Value
Although volatility is traditionally quoted as a standard deviation, the VIX Index is usually written as a percentage. So you get the VIX value from the standard deviation by multiplying it by 100. This is the expected annualized volatility for 30-day options, at a 68% confidence limit (one standard deviation of the normal probability curve).
The Old Method of Calculating the VIX Index
The CBOE has modified the method of calculating the VIX Index twice. Here’s a summary of the two previous methods:
September 2003 to October 2014
Between the 22nd of September 2003 and the 5th of October 2014, the monthly SPX options were used in calculating the VIX, although it followed a similar formula and methodology. Then, the rule was to use two nearest monthly options with at least one week to expiration.
For instance, if the nearest monthly options have 3, 33, and 65 days to expiration, the first month (with 3 days to expiration) would be ignored, and the following two months (33 and 65 days) would be used to calculate the VIX. And when interpolating the two variances to get the 30-day variance, the options with 33-day expiration would get a weight that is greater than 1 while the 65-day expiration would get a negative weight.
When the weekly SPX options became available and liquid enough, the CBOE switched to the weekly options on the 6th of October 2014 to zero in on the 30-day target and make the calculation more precise. But the pre-2014 version, which used monthly options, is still being calculated — now under the symbol VIXMO.
Prior to September 2003
Before the 22nd of September 2003, the calculation of the VIX was totally different. See how it compares with the new method:
- In the old method, the S&P 100 option (OEX) prices were used, unlike the S&P 500 options (SPX) used in the new method
- In the old method, at-the-money options alone were used, but in the new method, a wide range of options are used
- The formula used by the old method involved the option pricing model, but the new method uses a direct formula to derive the volatility
The CBOE still calculate and publish the old method index under the symbol VXO. You should note that the values of the old method index are different from the what we have now as VIX Index, so they should be treated as different indexes. However, while the daily historical data for the VIX is available from 1990, the VXO historical data covers as far as 1986, capturing the Black Monday event of 1987.
How to Interpret the VIX
Quoted in percentage points, the VIX index represents the expected price range of the S&P 500 Index for the year, at 68% confidence level. So, supposing the VIX reads 20%, for example, it means that the S&P 500 Index is expected to move up or down by about 20% in a year, with a 68% probability. In other words, there’s a 68% chance that the S&P 500 Index will move 20% in either direction for the year.
Typically, a reading of 20 or less is considered to reflect certainty and a stable rising market. A VIX reading of 20% or more is considered to imply a higher risk environment.
To get the implied volatility range for a single month, you will need to calculate the statistical equivalent of the annual value for a single month. For the 20% annualized value in our example above, you will need to divide it by √12 (not just 12), which will give you about 5.77%. So the monthly price movement for the S&P 500 would be +/- 5.77%.
Similarly, to get the weekly implied volatility from the annualized value, you divide by √52 (which would give you a 2.77% move per week). And getting the daily value would require you to divide by √365, giving you a 1.05% move per day.
What Does the VIX Index Tell You?
The fact that the VIX is calculated from the call and put options premiums shows that it tracks the sentiments in the market. Although it does not track what is happening in the stock market directly, it can tell when investors, especially the institutional players are trying to hedge their portfolios by buying or selling different types of options contracts.
Because of the size of their positions in the market, when the institutional investors perceive that the market is about to reverse to the downside, they can’t offload their positions in the stock market quick enough. So they turn to options to hedge their risk exposures — to a large degree by buying put options.
These activities of the smart money eventually affect the demand and supply for the various types of options. And as you know, imbalances in demand and supply will affect the prices of the options, which would, in turn, reflect on the value of the VIX Index.
So Why Does the VIX Move?
When the smart money thinks bearishly, they buy more put options and sell call options, driving up the demand for put options and effectively pushing the put prices higher as demand outpaces supply. Also, the fact that declining markets tend to be more volatile than ascending markets, makes investors willing to pay larger premiums on puts, in order to protect their positions. The larger premiums will cause the VIX Index to rise, since a larger premium implies that the market is expecting higher volatility.
On the other hand, when the market is calm and ascending — there’s little fear of a decline — the demand for put options declines, and the supply will increase as investors are selling put options and buying call options (effectively taking long positions in the market). Since there is little fear, and the market is expected to be calm going forward, fewer resort to options. The lower demand for options, in particular put options, drives the option premiums down, causing the VIX to decline. Another important aspect is that a rising market tends to be less volatile, which also lowers the premium on options when investors feel safer in their positions.
Therefore, most times when the VIX Index is rising, the broad stock market index (S&P 500 Index) is selling off because of fear, and when the VIX Index is going down, the stock market is trending up as investors are more confident.
Due to the way the VIX Index behaves like a contrarian indicator, when it spikes up beyond its usual levels, it may actually be a good time to buy stocks as other investors are gripped by fear and the market is bottoming. And when it falls lower, it may be an indication to sell stocks as the market may be topping — more on this later.
In the charts below, you can see how the VIX spiked around a market reversal.
There are situations when the inverse relationship between the VIX and the S&P doesn’t hold. In fact, around 20% of the time, the S&P 500 moves in the same direction as the VIX, as in the image below.
Many times what happens is that institutional players sense a weakness in the stock market trend and rush to the options market to hedge their risk, which pushes the VIX Index higher. However, retail investors are still busy buying stocks and continue to push the market higher.
In many cases, this happens after a long bull run, when fear begins to grow that the market cannot continue up for much longer.
How the VIX Behaves
Just like the call/put ratio, the VIX Index is mean reverting and behaves like a contrarian indicator. That is, after reaching a certain high level, it turns downwards, and after reaching a certain low level, it turns upwards. However, the behavior of the VIX Index depends on the timeframe you’re looking at since. For example, in very low timeframes, the index can be trending.
Generally, the index:
- trends in most intraday timeframes
- mean-reverts on the medium term
- may stay in the same range for the long term
- can make big spikes during market crashes and quickly turn down.
On some days, the VIX Index do form trends on the intraday timeframes like the 5-minute or 15-minute timeframes. In the VIX Index chart below, you can see the index is in an uptrend.
Mean Reversals on the Medium Term
In daily and weekly timeframes, the VIX Index is normally mean-reverting. It rises until it reaches some high levels and then turns and heads downwards. It will fall until it reaches the low levels and then reverses again to the upside.
Take a look at the Daily and Weekly charts below: You can see how the index goes up and down. Note that the Weekly chart is measured in percentage change. See how the index tends to bounce off the black line and the red line.
In the long term, the index is still mean-reverting but may stay between certain levels for a long time. From the Monthly chart below, you can see that the index spent most of the time around the black and bounces between the black and red lines, roughly between 10 and 40.
The Big Short-Lived Spikes
Sometimes, the index can make sudden big spikes during market crashes, such as the market crash in 2008 to 2009. You can see from the monthly charts below how the index tends to respect the red line but then, made a big spike in 2008. In fact, on the 24th of October 2008, the VIX index reached as high as 89.53 — the highest so far.
Backwardation and Contango
To understand what contango and backwardation are, you need to understand what a futures curve is. A futures curve is a line graph connecting the prices of futures contracts with the same underlying assets but different expiration dates. The Y-axis of the chart represents the futures prices while the X-axis represents the expiration dates.
The chart is similar to the yield curve used for money markets and bonds to show interest rates of different maturities. When the futures curve is used to display the prices of individual VIX futures contracts, it is called the VIX futures curve or the VIX futures term structure.
Chart courtesy of vixcentral.com
A VIX futures curve is known as contango when it is sloping upwards from left to right — in this situation, the market is said to be in contango. It means that the near-term VIX futures are priced lower than the longer-term VIX futures. What this implies is that the market is pricing in the expected rise in the VIX Index in the months ahead.
Take a look at the chart above. You can see that the VIX spot value is 17.77, indicated by the green line. Now, see the curve itself which is colored blue, with tick dots indicating the prices of the various futures contracts. From the chart, you can see that between August and September and again between December and February the market is in contango.
Because of the mean-reverting nature of the VIX Index and its tendency to perform spikes once in a while, contango occurs most of the time in VIX futures when the spot VIX Index is low.
An opposite condition gives rise to what is known as backwardation. It is when the near-term VIX Index futures are more expensive than the longer-term VIX Index futures, and the VIX futures curve is sloping downwards from the left to the right. So the market is anticipating a decline in the VIX Index from its present level in the months ahead.
From that chart above, you can see that from September to December, the VIX Index futures prices were going down, indicating that the market was in backwardation. Again, from February to March, the market was in backwardation.
It is worth noting that although backwardation is not uncommon, it occurs less frequently than contango in the VIX Index futures. The reason is that the VIX Index doesn’t stay long at high levels and tends to revert to lower values. Typically, backwardation occurs when the spot VIX Index spikes and the market naturally expect a decline in volatility going forward.
Futures traders try to use contango and backwardation to time the market.
The Different Types of VIX
In addition to the VIX Index, the CBOE calculates many other broad market volatility indexes such as the ones below:
- Volatility indexes on other U.S. stock indexes
- Volatility indexes on Non-U.S. stock ETFs
- Volatility indexes on currency-related futures/ETFs
- Volatility indexes on Interest rates
- Volatility indexes on commodity-related ETFs
- Volatility indexes on single stocks
- Volatility of VIX
Volatility Indexes on Other U.S. Stock Indexes
The volatility indexes under this group are as follows:
CBOE NASDAQ-100 Volatility Index:
With the ticker symbol VXN, the CBOE NASDAQ-100 Volatility Index measures the implied volatility conveyed by 30-day NASDAQ-100 Index option prices. The VXN is quoted in percentage points, just like the VIX. It is a leading barometer of investors’ sentiments about the NASDAQ-100 Index.
CBOE S&P 100 Volatility Index:
This is the continuation of the volatility index CBOE introduced in 1993, which was based on the S&P 100 index (OEX) options prices. It now disseminated under the ticker symbol VXO, but before September 2003, it was known as VIX Index. The index has a price history dating back to 1986.
CBOE DJIA Volatility Index:
The CBOE DJIA Volatility Index, known by the ticker symbol VXD, is based on the prices of options on the Dow Jones Industrial Average. It measures the market’s expectations of 30-day volatility implicit in the prices of DJIA options. It is quoted in percentage points.
CBOE Russell 2000 Volatility Index:
This index is a key measure of expected volatility implicit in the prices of 30-day Russell 2000 Index options. It is represented by the ticker symbol RVX, and it’s quoted in percentage points. The index is a leading barometer of investors’ expectations in the Russell 2000 Index.
CBOE S&P 500 9-Day Volatility Index:
Known by the ticker symbol VIX9D, the CBOE S&P 500 9-Day Volatility Index provides investors’ expectations of 9-day future volatility, unlike the 30-day volatility implied by the standard VIX. But just like the VIX Index, it is calculated with the S&P 500 Index option prices.
CBOE 3-Month S&P 500 Volatility Index:
This index is a measure of 3-month implied volatility of the S&P 500 Index (SPX) options. Its ticker symbol was VXV until it was changed to VIX3M in September 2017. It is quoted in percentage points but tends to be less volatile than VIX.
CBOE S&P 500 6-Month Volatility Index:
Its ticker symbol is VIX6M, and it measures the implied volatility of the S&P 500 Index options over a 6-month time horizon. The VIX6M is estimated using the VIX method applied to SPX options with 6 to 9 months expiration.
CBOE 1-year volatility Index:
Known by the ticker symbol VIX1Y, the CBOE 1-year volatility Index measures the market expectation of full-year volatility of the S&P 500 Index options. It is calculated with the prices of 1-year SPX options. Just like the standard VIX Index, it is quoted as percentage points, but it appears to be less volatile.
Volatility Indexes on Non-U.S. Stock ETFs
These are volatility indexes that are based on non-U.S. Equity ETFs, and they include:
CBOE EFA ETF Volatility Index:
Known by the ticker symbol VXEFA, the CBOE EFA ETF Volatility Index was introduced in 2013. It measures the implied volatility of the iShares MSCI EAFE Index Fund (EFA), which is an exchange-traded product that deals with developed-market stocks in Europe, Australia, Asia, and the Far East.
CBOE Emerging Markets ETF Volatility Index:
Its ticker symbol is VXEEM, and it uses the VIX methodology to measure the expected volatility of the EEM ETF, which is the iShares MSCI Emerging Market Index.
CBOE China ETF Volatility Index:
Known by the ticker symbol VXFXI, the CBOE China ETF Volatility Index measures the expected volatility in the FXI ETF, an exchange-traded product based on the Chinese equity market. The VXFXI is calculated with the VIX Index methodology.
CBOE Brazil ETF Volatility Index:
This volatility index is calculated with the same VIX methodology to reflect the implied volatility in the EWZ ETF, an exchange-traded fund that is based on the Brazilian equity market. The ticker symbol is VXEWZ.
Volatility Indexes on Currency-Related Futures/ETFs
The CBOE now offer volatility indexes on four currency-related instruments, and they include:
CBOE/CME FX Euro Volatility Index:
This volatility index is calculated by applying the VIX methodology to options on EUR/USD. Known by the ticker EUVIX, the CBOE/CME FX Euro Volatility Index measures the market’s expectation of 30-day EUR/USD volatility.
CBOE/CME FX Yen Volatility Index:
Its ticker symbol is JYVIX, and it measures the implied volatility of the USD/JPY by applying the VIX methodology to options on the currency pair.
CBOE/CME FX British Pounds Volatility Index:
This index measures the market’s expectation of 30-day GBP/USD volatility by applying the VIX methodology to options on the curry pair. Its ticker symbol is BPVIX.
CBOE EuroCurrency ETF Volatility Index:
Known by the ticker symbol EVZ, the CBOE EuroCurrency ETF Volatility Index measures the market expectations of 30-day volatility of the USD/Euro exchange rate by applying the VIX methodology to options on the CurrencyShares Euro Trust (FXE).
Volatility Indexes on Interest rates
CBOE/CBOT 10-year U.S. Treasury Note Volatility Index:
This index uses the VIX methodology to measure the 30-day implied volatility of 10-Year Treasury Note futures prices. Its calculation is based on the prices of CBOT’s actively traded options on Treasury Note futures. It was initially known by the ticker VXTYN, but the ticker has since been changed to TYVIX.
CBOE Interest Rate Swap Volatility Index:
This is the first standardized volatility measure in the interest rate swap market. It is based on 1-year swaptions on 10-year U.S. Dollar interest rate swaps, which is the benchmark for the USD interest rate market. Its ticker is SRVIX, but it’s often written as SRVIXed, where e stands for a 1-year expiration and d for a 10-year tenor.
Volatility Indexes on Commodity-Related ETFs
These are volatility indexes based on commodity-related exchange-traded products, and they include:
CBOE Crude Oil ETF Volatility Index:
This uses the VIX methodology to measure the market’s expectation of 30-day volatility of crude oil prices. It is calculated from the prices of the U.S. Oil Fund, LP, and the ticker is OVX.
CBOE Gold ETF Volatility Index:
It measures the market’s expectations of 30-day volatility of gold prices by using the VIX methodology on SPDR Gold Shares options. The ticker is GVZ.
CBOE Silver ETF Volatility Index:
The index measures the implied volatility of the SLV ETF by using the VIX methods on the SLV ETF options. Its ticker is VXSLV.
CBOE Gold Miners ETF Volatility Index:
This measures the implied volatility of the GDX ETF, using the VIX methodology. The ticker is VXGDX.
CBOE Energy Sector ETF Volatility Index:
It measures the implied volatility of the XLE ETF by applying the VIX method to options on XLE ETF, and its ticker is VXXLE.
Volatility indexes on single stocks
CBOE Equity VIX on Amazon:
By applying the VIX methodology to options on Amazon stocks, this index measures the expected volatility on Amazon stock price. The ticker is VXAZN.
CBOE Equity VIX on Apple:
With the ticker VXAPL, this index measures the implied volatility of Apple stock using the VIX method.
CBOE Equity VIX on Goldman Sachs:
The ticker is VXGS, and it measures the expected volatility of Goldman Sachs stock by applying the VIX methodology to its options.
CBOE Equity VIX on Google:
This index measures the implied volatility of Google stock, and its ticker symbol is VXGOG.
CBOE Equity VIX on IBM:
Known by the ticker VXIBM, this index uses the VIX method to measure the implied volatility of IBM stock.
Volatility of VIX
With a ticker symbol VVIX, this is the volatility index of the VIX Index itself. The CBOE VIX of VIX Index is a measure of the expected volatility of the 30-day forward price of the VIX, and it is derived from nearby VIX option prices.
Securities That Track the VIX
Since the CBOE recalculated the VIX index in 2003, a lot of securities — that use the VIX Index as their underlying — have been created to help traders and risk managers benefit from the unique way the index moves relative to the stock market. This has given rise to a new set of tradable asset classes that rely solely on the market’s expectation of volatility.
The different types of securities through which traders can trade the VIX Index include:
- VIX futures
- VIX options
- VIX exchange-traded products
The CBOE introduced VIX futures on its new futures exchange, the CFE, in 2004. The VIX futures contracts are based on the market’s estimates of the value of the VIX Index on various expiration dates in the future. Just like the equity futures, the settlement is by cash rather than an exchange of the underlying asset.
There are different types based on the expiration time horizon. The monthly and weekly futures are available and trade almost 24 hour per day and five days a week. Weekly expirations are usually listed on Thursdays and expire on Wednesdays. The settlement value is determined on the morning of the expiration date through a Special Opening Quotation (SOQ) of the VIX Index.
According to the CBOE, the VIX option has been the most successful new product in CBOE’s history since its introduction in 2006. In fact, the VIX futures and options have been named the Most Innovative Index Products, and in 2015, combined trading activity in VIX options and futures grew to nearly 800,000 contracts per day.
The VIX options provide market participants with another tool to manage volatility risk and speculate, based on their views of the future direction of the VIX Index. Both monthly and weekly options are available and trade during the U.S. regular trading hours and, again, from 2:00 a.m. to 8:15 a.m. CT.
VIX Exchange-traded Products (ETPs)
These are exchange-traded products that attempt to track the movement in the VIX Index through a basket of VIX futures. They include the VIX exchange-traded funds (ETFs), which hold stakes in the underlying VIX futures, and the exchange-traded notes (ETNs), which don’t hold the underlying assets.
The most popular VIX ETFs includes:
- ProShares Short VIX Short-Term Futures ETF: Known by the ticker SVXY, this fund tries to replicate the inverse of an index of VIX short-term futures contracts. It provides a 0.5 exposure to the underlying.
- ProShares Ultra VIX Short-Term Futures ETF: It is listed with the ticker UVXY, and it tracks an index of VIX short-term futures contracts. The fund provides leveraged exposure of 150%.
- ProShares VIX Short-Term Futures ETF: Its ticker is VIXY, and it tracks an index of short-term VIX futures contracts.
- ProShares VIX Mid-Term Futures ETF: Known by the ticker VIXM, this ETF replicates an index of VIX mid-term futures contracts. Consisting of longer-dated futures contracts, it may show a diminished correlation with the VIX Index.
Popular VIX ETNs include:
- iPath S&P 500 VIX Short-Term Futures ETN: Its ticker is VXX or VXXB, and it tracks an index of VIX short-term futures contracts.
- iPath S&P 500 VIX Mid-Term Futures ETN: Listed with the ticker VXZ or VXZB, this ETN tracks an index of VIX medium-term futures contracts. Because it tracks longer-dated futures contract, it may show a reduced correlation to the spot VIX.
- VelocityShares Daily 2x VIX Short-Term ETN: It is known by the ticker TVIX. This ETN tracks an index of VIX short-term futures contracts, and it carries 200% leverage.
- VelocityShares VIX Short-Term ETN: Its ticker symbol is VIIX, and it seeks to replicate the daily performance of the VIX short-term futures.
- VelocityShares Daily Inverse VIX Short-Term ETN: Known by the ticker XIV, this ETN was tracking the opposite movement in the VIX Index. It gains when the VIX is going down. A sudden rise in volatility in early February 2018 decimated it, and it was delisted.
It is important to note that all these ETPs don’t directly track the VIX Index, so they don’t perfectly correlate with the index. Furthermore, these products, especially the short-term ones, suffer from the effects of contango since they are more like the VIX futures term structure than the VIX Index. See the chart below: Red is for the VIX, and blue is for VXX.
How to Trade the VIX
The creation of the volatility index has offered traders and fund managers new opportunities for speculation, risk management, and diversification. But as we have already stated before, you can’t directly trade the VIX Index.
To benefit from the movements in the VIX Index, you have to trade any of the securities that are based on it, such as the VIX options, futures, and ETPs. Choose the security that fits your objectives and find a suitable strategy for trading it.
Strategies for trading the VIX
Here are some of the strategies you can employ when trading any of the VIX-based securities:
This is a simple strategy that is based on the fact that the VIX tends to revert towards the mean after spiking up or falling below certain levels. So you look to short when the index spikes and to go long after it has fallen to low levels. You may want to combine it with the S&P 500 index to filter only the spikes that correspond with market lows.
In the chart above, you can see the blue arrow indicating the right time to go long on VIX — VIX at low and SPX at peak. The purple arrow shows the VIX spike and the SPX bottom. Notice how the 10-day moving average smoothens the spikes.
VIX Contango Strategy
Because the VIX Index stays mostly at the lower levels, VIX futures are frequently affected by the contango effect. That is, when the VIX Index is at low levels, the market already starts pricing in the expectation of a rise in the futures contracts before the rise occurs, eroding the returns in the ETPs that go in the same direction as the VIX Index (e.g., VXX).
So going long on an inverse ETP like the SVXY when the VIX Index is at the low levels becomes a better strategy at that point. Then when the Index is ascending, you can switch to the VXX.
Moving average volatility ratio (MAVolRatio)
Here, we are trying to use a ratio of implied volatility to historical volatility after smoothening them with a simple moving average. Here is what you do:
- Get an 8-day SMA of the VIX
- Get a 15-day SMA of the historical volatility (HV)
- Calculate the MAVolRatio: MAVolRatio = 8-day SMA of VIX / 15-day SMA of HV
- If the MAVolRatio is greater than 0.75, go long on the SVXY or similar inverse products
- If the MAVolRatio is less than 0.75, go long on the VXX or other similar same-direction products (e.g., VIIX)
As with everything you read on the internet, it is important to backtest first! The presented strategies are merely concepts, and while some may have worked well, nobody can ensure that they will continue to work going forward!
Technical Tools for Analyzing the VIX Security
Many of the tools used in technical analysis of stocks can also be used to technically analyze VIX-based products. Here, we will take a look at three common tools:
Moving averages can help smoothen the spikes so that you can easily appreciate the up and down swings in the index. The type and period of the moving average is a matter of choice.
You can combine two moving averages and use a crossover of the faster one as an indication for trades. See the chart below. Note that it’s important to backtest every method before use.
The bolllinger bands is a quite special tool in the sense that it also shows when volatility is increasing or decreasing. It does so by widening or narrowing the range between the upper and lower band in response to the volatility of the market.
See the chart above. Notice how it expands when volatility increases and narrows when volatility reduces.
Since VIX is mean reverting, the lower or upper Bollinger bands could be used to define when the VIX has gone too far, and will revert soon!
The RSI is a momentum oscillator. Since the VIX Index is prone to rising and falling, oscillators like the RSI can be very helpful in identifying trading opportunities. Lookout for divergences, as can be seen in the chart below.
Creating a Synthetic VIX: the VIX Fix Indicator
There’s another way to track investor sentiments in the market, which closely correlates with the VIX. In fact, it is a simple indicator, and you can use it to check the volatility in any security, especially those securities whose volatility indexes have not been created — some individual stocks and ETFs, for example.
The synthetic VIX was created by Larry Williams to help estimate volatility and gauge investors’ fear in those securities that don’t have volatility index. But the synthetic VIX can be used for any market, including the ones that already have the VIX since it parallels the actual VIX and works very fine.
Interestingly, the formula for the VIX Fix is a very simple one, especially when compared to the time-consuming and complicated calculations made in the VIX Index. See the formula below:
VIX FIX = [Highest (Close,22) – Low] / [Highest(Close,22)] x 100
Highest (Close,22) = the highest close of the last 22 bars
Low = the low of the current bar
100 is the normalizing factor
It is that simple: Get the highest close of the last 22 bars, subtract the low of the current bar from it, divide what you get by the highest close of the last 22 bars, and finally, multiply the result by 100 to normalize the indicator’s readings. Williams used 22 bars because for the daily timeframe, the maximum number of days in a month is 22. Take a look at the charts below:
This is a daily chart of the S&P 500 Index with the CBOE VIX Index and the VIX Fix attached. Notice how the VIX Fix closely follows the VIX Index, rising when the S&P 500 Index is falling and declining when the S&P 500 is rising.
This is a weekly S&P 500 chart — similar result.
This is a Microsoft daily chart. You can see the 20-period moving average added to the VIX Fix. It can serve as a signal line if you want to use the indicator to look for trade entries.
You can add a Bollinger band if you want, as you can see in this Facebook chart.
What is IVX?
The IVX is an acronym for Implied Volatility Index, and it measures an intraday implied volatility for individual stocks or exchange-traded funds in the U.S. market. This index was developed about 10 years ago by IVolatility.com, a data and analysis service provider.
IVX is fundamentally similar to VIX in that it measures the expected volatility over a future period. But it measures the volatility in individual stocks and ETFs, not just for stock indices.
According to IVolatility.com, IVX is calculated by using a proprietary weighting technique which factors in the Delta and Vega of four at-the-money options of an individual stock. The IVX is normalized to fixed tenors — 30, 60, 90, 120, 150, 180, 360, and 720 days — using a linear interpolation by the square root of time.
Simply put, IVX compares the cost level of the options for the specified security to its historical levels. Despite the difference in the method of calculation, the IVX and VIX perfectly correlate, as you can see in the picture below:
Sourced from IVolatility.com
The Difference Between IVX and VIX
Traders and investors use volatility indexes to gauge the sentiments in the market. We’ve provided you with a definitive guide that will help you understand all you need to know about the VIX Index and other means of tracking volatility.