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Tracking Volatility How the VIX is Calculated_1

Post on: 18 Июль, 2015 No Comment

Tracking Volatility: How the VIX is Calculated 5.00 / 5 (100.00%) 1 vote

Those who have been paying attention to investment markets for some time most likely remember the term volatility index. Whenever the market took a sudden turn up or down, business reports would make reference to this index. It is still around, but now is known as the VIX. Regardless of what it is called, there is one important thing to know when tracking volatility: How the VIX is calculated.

The VIX is a creature created by the Chicago Board Options Exchange (CBOE) as a way of looking at the presumed volatility of the options index of the S&P 500. It is intended to show the potential for stock volatility during the next 30 days and so often is referred to as the fear index.

The CBOE determines and disseminates the VIX in real time. In theory, it is a value that is arrive at by weighting the prices of a variety of options that are included in the S&P 500 options index. It is calculated as a percentage that roughly translates into the expected movement of the index, either up or down, over the next 30 days. This figure is then annualized. The index has a probability rate of 68 percent, meaning it is right about 68 percent of the time.

As an example, say the VIX stands at 15. That means that there is a 68 percent chance that the index options market will move up or down by less than 15 percent, on an annualized basis, or it will move by about 4.33 percent in the next month.

The concept of the VIX is much easier to understand for most than the actual math behind the calculation. In fact, in a CBOE paper, the section that explains how they calculate the VIX takes up a full 15 pages.

Suffice it to say that the VIX is useful because it helps investors gauge the mood of the market. This can, in turn, help them make important decisions about whether this is the right time to buy or sell. It also provides its own investment opportunities. Since market volatility often is seen as meaning negative performance, volatility investments can be used as a hedge against risk. Volatility can, however, also mean that markets are likely to rise rapidly, so this type of speculation in VIX options and futures can be complex.

There are a number of vehicles available to professional traders that offer VIX futures and options that those in the know can use to play their hunches. For the average investor, there are other avenues to take advantage of volatility trading, including volatility exchange-traded funds, or EFTs.

The bottom line for investors is that whether they are speculating or using investments as a risk hedge, investing in market volatility is something that requires a good understanding of the market, the types of investment vehicles that are available, and the potential outcomes. Volatility investments are not the type to jump into lightly. Still, the fact remains that in tracking volatility: How the VIX is calculated is a must to know.