The VIX
The Chicago Board Options Exchange’s Volatility Index—or VIX—is based on option prices on the S&P 500 stock index.
It attempts to quantify investors’ expectation of stock market (S&P 500) volatility over the next 30 days. It is then quoted as an annualized standard deviation.
The VIX is commonly referred to as the market’s ‘fear gauge’.
Interpreting the VIX
Say the VIX is presently 10. This means there is about a 68% chance (one standard deviation) that the absolute value of the market’s return will be less than `\frac{10}{\sqrt{12}} = 2.89` over the next 30 days (one month).
- We divide by `\sqrt{12}` to convert from the annualized volatility (in which VIX is quoted) into the monthly volatility.
The VIX and the Stock Market
The VIX and the stock market tend to move in opposite directions.
- In finance, this is known as theleverage effect.
You can see this effect in the following slide, which plots the S&P 500 index and the VIX.
The VIX is highest when the market (S&P 500) experiences large losses.
See AlsoVIX | S&P Dow Jones IndicesYou can select subintervals by clicking and dragging on the chart.
The VIX and the Stock Market
The VIX, or Chicago Board Options Exchange’s Volatility Index, is a vital metric in finance, derived from S&P 500 option prices. It essentially gauges the market's expectation of volatility in the S&P 500 over the coming 30 days. This index is quoted as an annualized standard deviation and is often called the market's 'fear gauge' due to its correlation with investor sentiment during uncertain times.
Interpreting the VIX involves understanding its numerical value. For instance, if the VIX stands at 10, it implies a 68% probability (one standard deviation) that the absolute value of the market’s return will fall within approximately 2.89 over the next 30 days. This calculation involves dividing the VIX value by \sqrt{12} to transition from annualized volatility to monthly volatility.
The VIX's movement typically inversely correlates with the stock market, a phenomenon termed the leverage effect in finance. This relationship is observable when comparing the trends of the S&P 500 index and the VIX. During periods of significant market losses, the VIX tends to spike, reflecting higher levels of perceived volatility and market uncertainty.
Now, breaking down the concepts mentioned in the article:
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VIX (Volatility Index): A measurement derived from S&P 500 option prices, representing anticipated stock market volatility over the next 30 days, expressed as an annualized standard deviation.
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S&P 500: A stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States, widely used as a benchmark for the overall market's health.
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Volatility: Refers to the degree of variation of trading prices over time for a financial instrument, often used as a measure of risk or uncertainty in the market.
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Standard Deviation: A statistical measure of the amount of variation or dispersion of a set of values from its mean, used in finance to quantify the volatility of a financial instrument or market.
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Leverage Effect: Describes the phenomenon where changes in the value of an asset are amplified or magnified, resulting in an inverse relationship between the VIX and the stock market's movement.
Understanding these concepts provides a comprehensive grasp of how the VIX operates and its implications for market behavior and investor sentiment.
