Finance: What is the Volatility Index (VIX)?

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Transcript

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of quote market volatility unquote using sophisticated statistical measures But

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in essence the vics is a reflection of expected options

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Volatility like it kind of trades like a stock because

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the elements that comprise it come from current market prices

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of options on a variety of indices So what does

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that mean in English again What the vics comes from

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things like Calls on Nasdaq puts on the Russell 2000

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way out of the money calls inputs on the S

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and P 500 That air long dated you know stuff

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like that Well the vics was created in 1993 by

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the CBO your Chicago Board of Options Exchange to make

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the management of hedging all the more liquid easy and

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well lucrative the easier the indices are to use while

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the more liquid the system and the more options contracts

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then that get traded and the more commissions than that

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Get aid So more money for everyone right Then again

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not so much more money for professional options traders Less

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money for cardiologists trying to be smarter than the $1,000,000

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a week Goldman Sachs people The backdrop here is that

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the fixes the key driver in the pricing of options

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That is the more volatile the market the more valuable

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options become both in hedging positions i e Playing investment

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defense and in simply trading options When things are volatile

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there exists more risk more money to be made more

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money to be lost That happens So why do options

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become more valuable when they're volatility is higher We'll take

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a stock and 40 bucks a share with modest volatilities

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such that in the last year it's traded as high

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as 45 bucks a share in its low is 35

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bucks a share A call option with a strike price

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of college 47 50 would probably be pretty cheap if

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it were bought when the stock was trading close to

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35 it had an 045 months to expire And this

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makes sense because the stock would have to go up

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over 12 and 1/2 dollars for that option to be

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at all in the money Remember that a stock prices

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and kind of like a floating piece of cork in

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the ocean It's absorbed a lot of water that is

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in a calm sea The court can drop a couple

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of feet in the water and a fish can pop

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it up in the air a few feet and a

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little kind of trade on its own But in rough

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seas idea Volatile overall market Well that cork will not

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only go up and down the two feet it travels

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on its own but will be market multiplied by some

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meaningful factor of the ocean tides going a 14 feet

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up here and then 14 feet down Yeah so if

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you take this very modestly volatile stock and then place

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it in ah hi Vicks market volatile environment Well all

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of a sudden the odds that that stock could trade

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above 47 50 for some period of time before it

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expires making the option worth more than a penny or

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two Well then that risk suddenly gets very riel and

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the pricing of those options immediately reflect that risk or

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that positive upside of making money on the call options

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you bought That is one can imagine that in a

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market that upper down three or 4% per day idea

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very volatile market Hello late 19 nineties The market gets

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on a roll and the entire market goes up then

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20% in a few quarters That's the entire market including

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boring stocks like G and T and stuff like that

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Well that long dated option you bought for a dime

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when the stock was trading at 38 12 with the

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strike price of 47 50 will just based on the

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overall market going up 20% And in this particular stock

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having a good quarter could make it trade for 50

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bucks a share Putting that option $2.50 in the money

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and giving you a 25 x return on the dime

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per option investment that you made and about five months

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earlier So yeah I think about the fixes the ocean

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because it represents the overall volatility of the market itself

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It then plays into the pricing of options or pieces

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of cork floating in the waves And yeah that's the

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vics Apply liberally to your problem areas