VIX - CBOE Volatility Index
Categories: Derivatives, Metrics
A measure of market volatility, commonly used to calculate the values of stock options.
You’d think it’d be a measure of political arguments at Thanksgiving, right? But it’s not. Even if it should be.
The Volatility Index, or VIX (no relation to the Vapo Rub), is a measure of "market volatility," using sophisticated statistical measures. But, in essence, the VIX is a reflection of expected options volatility, because the elements that comprise it come from current market prices of options on a variety of indices. That is, things like calls on NASDAQ's changes, ticker: QQQQ, puts on the Russell 2000, etc...way out-of-the-money calls and puts on the S&P 500. Stuff like that.
The VIX was created in 1993 by the Chicago Board of Options Exchange to make the management of hedging all the more liquid, easy, and, well…lucrative. The easier the indices are to use, the more liquid the system and the more options contracts that get traded.
So…more money for everyone, right? Um, yeah. Not so much. More money for professional options traders. Less money for cardiologists trying to be smarter than Goldman Sachs’ finest.
The backdrop here is that the VIX is the key driver in the pricing of options. That is, the more volatile the market, the more valuable options become in hedging positions, i.e. playing investment defense. Why do they become more valuable? Take a stock trading at $40, with modest volatility, such that, in the last year, it has traded as high as $45 and as low as $35. A call option with a strike price of $47.50 would probably be pretty cheap. And remember that a stock price is kind of like a floating piece of cork in the ocean that has absorbed a lot of water. That is, in a calm sea, the cork can drop a couple feet in the water and a fish can pop it up into the air a few feet, and it will kind of trade on its own. But in rough seas, i.e. a volatile overall market, that cork will not only go up and down the 2 feet it travels on its own, but will be market-multiplied by some meaningful factor.
So if you take this very modestly volatile stock, and then place it in a high-VIX market volatile environment...all of a sudden, the odds that that stock could trade above $47.50 for some period of time, making that option more than worth a penny or two, suddenly gets very real, and the pricing of those options immediately adjusts to that climate.
So think about the VIX as the ocean, because it represents the overall volatility of the market itself. It then plays into the pricing of options, or pieces of cork, floating in the waves.
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Finance: What is the Volatility Index (V...2 Views
and finance Allah shmoop What is the volatility index or
Vicks No it's not this stuff not put that on
your equity trading sheet It just makes a mess and
little smells bad And no it's not a pre moistened
add either The volatility index Our vics is a measure
of quote market volatility unquote using sophisticated statistical measures But
in essence the vics is a reflection of expected options
Volatility like it kind of trades like a stock because
the elements that comprise it come from current market prices
of options on a variety of indices So what does
that mean in English again What the vics comes from
things like Calls on Nasdaq puts on the Russell 2000
way out of the money calls inputs on the S
and P 500 That air long dated you know stuff
like that Well the vics was created in 1993 by
the CBO your Chicago Board of Options Exchange to make
the management of hedging all the more liquid easy and
well lucrative the easier the indices are to use while
the more liquid the system and the more options contracts
then that get traded and the more commissions than that
Get aid So more money for everyone right Then again
not so much more money for professional options traders Less
money for cardiologists trying to be smarter than the $1,000,000
a week Goldman Sachs people The backdrop here is that
the fixes the key driver in the pricing of options
That is the more volatile the market the more valuable
options become both in hedging positions i e Playing investment
defense and in simply trading options When things are volatile
there exists more risk more money to be made more
money to be lost That happens So why do options
become more valuable when they're volatility is higher We'll take
a stock and 40 bucks a share with modest volatilities
such that in the last year it's traded as high
as 45 bucks a share in its low is 35
bucks a share A call option with a strike price
of college 47 50 would probably be pretty cheap if
it were bought when the stock was trading close to
35 it had an 045 months to expire And this
makes sense because the stock would have to go up
over 12 and 1/2 dollars for that option to be
at all in the money Remember that a stock prices
and kind of like a floating piece of cork in
the ocean It's absorbed a lot of water that is
in a calm sea The court can drop a couple
of feet in the water and a fish can pop
it up in the air a few feet and a
little kind of trade on its own But in rough
seas idea Volatile overall market Well that cork will not
only go up and down the two feet it travels
on its own but will be market multiplied by some
meaningful factor of the ocean tides going a 14 feet
up here and then 14 feet down Yeah so if
you take this very modestly volatile stock and then place
it in ah hi Vicks market volatile environment Well all
of a sudden the odds that that stock could trade
above 47 50 for some period of time before it
expires making the option worth more than a penny or
two Well then that risk suddenly gets very riel and
the pricing of those options immediately reflect that risk or
that positive upside of making money on the call options
you bought That is one can imagine that in a
market that upper down three or 4% per day idea
very volatile market Hello late 19 nineties The market gets
on a roll and the entire market goes up then
20% in a few quarters That's the entire market including
boring stocks like G and T and stuff like that
Well that long dated option you bought for a dime
when the stock was trading at 38 12 with the
strike price of 47 50 will just based on the
overall market going up 20% And in this particular stock
having a good quarter could make it trade for 50
bucks a share Putting that option $2.50 in the money
and giving you a 25 x return on the dime
per option investment that you made and about five months
earlier So yeah I think about the fixes the ocean
because it represents the overall volatility of the market itself
It then plays into the pricing of options or pieces
of cork floating in the waves And yeah that's the
vics Apply liberally to your problem areas