What Is the VIX? The Cboe Volatility Index Explained

This calculation takes into account the implied volatility of these options, which is influenced by the supply and demand dynamics in the options market. 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. Remember, there is a risk of loss, with trading options and futures, so trade with risk capital only. 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.

A higher VIX value indicates higher expected volatility and uncertainty in the market, implying higher levels of fear or anxiety among investors. On the other hand, a lower VIX value suggests lower expected volatility, indicating a more stable and calm market. The VIX is considered a reflection of investor sentiment and has in the past been a leading indicator of a dip in the S&P 500, but that relationship may have changed in recent times.

For instance, in the three months between Aug. 8, 2017, and Nov. 8, 2017, the VIX was up 19%—seemingly suggesting anxiety among market participants and implying that the S&P 500 should be on a downward trajectory. Any estimates based on past performance do not a guarantee future performance, and prior to making any investment you should discuss your specific investment needs or seek advice from a qualified professional. While there are other factors at work, in most cases, a high VIX reflects increased investor fear and a low VIX suggests complacency. Historically, this pattern in the relationship between the VIX and the behavior of the stock market has repeated itself in bull and bear cycles, patterns we will look at in more detail below.

When uncertainty and fear hits the market, stocks generally fall, and your portfolio could take a hit. But because of how they’re constructed, even the best volatility ETFs tend to decline in value over time, even if they do spike higher in times of intense volatility. 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.

VIX and Stock-Market Behavior

The VIX Index, also known as the Fear Index or the Volatility Index, represents the market’s expectation of future volatility. Developed by the Chicago Board Options Exchange (CBOE), it measures the implied volatility of S&P 500 index options. It is calculated using a complex formula that takes into account the prices of options with different strike prices and expiration dates. It is a measure of the level of implied volatility, not historical or statistical volatility, of a wide range of options, based on the S&P 500. This indicator is known as the « investor fear gauge, » because it reflects investors’ best predictions of near-term https://forexanalytics.info/ market volatility, or risk. In general, VIX starts to rise during times of financial stress and lessens as investors become complacent.

Just keep in mind that with investing, there’s no way to predict future stock market performance or time the market. The VIX is merely a suggestion, and it’s been proven to be wrong about the future direction of markets nearly as often as it’s been right. That’s why most everyday investors are best served by regularly investing in diversified, low-cost index funds and letting dollar-cost averaging smooth out any pricing swings over the long term. Instead, investors can take a position in VIX through futures or options contracts, or through VIX-based exchange-traded products (ETPs). For example, the ProShares VIX Short-Term Futures ETF (VIXY) and the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX) are two such offerings that track a certain VIX-variant index and take positions in linked futures contracts.

VIX and the S&P 500

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. However, the index is far from perfect, and investors should consider how much weight they want to peg on it. Although the VIX revealed high levels of investor anxiety, the Investopedia Anxiety Index (IAI) remained neutral. The IAI is constructed by analyzing which topics generate the most reader interest at a given time and comparing a day in the life of a day trader that with actual events in the financial markets. It’s interesting to note that the VXN, which is the symbol for the implied volatility index of the Nasdaq 100 index, is even more bearish at the end of the summer of 2003. In Figure 2, the VXN, which is calculated the same way as the VIX, dropped to levels not seen since the complacent summer of 1998, when the VXN was below 29.5.

Cboe lists options contracts that derive their value from short-term VIX futures, and call options on VIX can be used to hedge equity portfolios in the expectation that VIX and stocks will continue to diverge over time. VIX calls and puts can also be used to bet on directional moves in the index itself, though traders should be aware of the unique expiry and settlement rules pertaining to VIX options. A higher VIX suggests increased market uncertainty and investor fear, while a lower VIX indicates a more stable market environment. As such, the VIX can provide valuable information for investors looking to assess market conditions and make informed investment decisions. When the VIX is high, it suggests that investors anticipate increased market volatility and fear. Conversely, when the VIX is low, it indicates a more complacent market environment.

What Is the VIX? This ‘Fear Index’ is Used for Active Investing

The VIX index is specifically measuring expected volatility for another index, the S&P 500. True to its name, the S&P 500 index is composed of 500 of the largest publicly traded companies in the U.S. Because the S&P 500 includes so many large companies across several different market sectors, it is generally viewed as a good indication of how the U.S. stock market is performing overall. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.

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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. 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. Experts understand what the VIX is telling them through the lens of mean reversion. In finance, mean reversion is a key principle that suggests asset prices generally remain close to their long-term averages.

1. Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues.
2. Conversely, when the VIX is low, traders may look for opportunities to buy options as a way to hedge their positions or speculate on potential market moves.
3. During the time period mentioned above, despite some concerns about the market, the overall IAI actually moved lower.
4. 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).
5. 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.
6. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.

Historically, there has been an inverse relationship between the VIX and market returns. When the VIX is high, indicating heightened market fear, it is often a signal that the market may be near a bottom. On the other hand, when the VIX is low, it suggests a more bullish sentiment and the possibility of a market top. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism.

Conversely, when the VIX is low, traders may look for opportunities to buy options as a way to hedge their positions or speculate on potential market moves. The CBOE Volatility Index (VIX) is a measure of expected price fluctuations in the S&P 500 Index options over the next 30 days. The VIX, often referred to as the « fear index, » is calculated in real time by the Chicago Board Options Exchange (CBOE). But for those who are more inclined to trade and speculate, ETFs that track the VIX can be a useful tool.

Our estimates are based on past market performance, and past performance is not a guarantee of future performance. Large institutional investors hedge their portfolios using S&P 500 options to position themselves as winners whether the market goes up or down, and the VIX index follows these trades to gauge market volatility. The CBOE Volatility Index (VIX) quantifies market expectations of volatility, providing investors and traders with insight into market sentiment. It helps market participants gauge potential risks and make informed trading decisions, such as whether to hedge or make directional trades. While the VIX itself is an index and cannot be traded, there are funds and notes investors and traders can participate in to gain exposure to the index. 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).

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

For example, on Nov. 9, 2017, the VIX climbed 22% during the trading session on fears of delays in the tax reform plan. 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. Get a custom financial plan and unlimited access to a Certified Financial Planner™ for just $49/month. As the derivatives markets matured, 10 years later, in 2003, the CBOE teamed up with Goldman Sachs and updated the methodology to calculate VIX differently.