What is the VIX?
VIX is a trademarked ticker symbol for the Chicago Board Options Exchange’s (CBOE’s) Market Volatility Index. The VIX was first introduced in 1993 and is constructed using the implied volatilities of a wide range of S&P 500 index options in an attempt to measure how much the market will fluctuate over the next 30 days, based upon an analysis of the difference between current put and call option prices. VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.
What does this mean in plain English? When the market starts to decline, investor “A” who own stock may purchase a put option from investor “B” to help protect against further or accelerating declines. Investor “B” is willing to sell the put contract to investor “A” in exchange for a guaranteed return and the forced obligation to purchase the stock from investor “A” if the stock drops far enough. Meanwhile, investor “X” may sell a call on their investment to investor “Y” to attempt to generate some income on their declining position. Investor “Y” is willing to pay a premium to investor “X” in the hopes that the decline is short lived and the stock will rebound and offer investor “Y” the opportunity to profit without having to risk more than the premium paid for the option. All of this buying and selling of call and put option contracts adds up to an increasing value of the VIX. So, importantly, the VIX does not drive volatility, it is simply a measure of volatility.
As you can see from the chart below, The VIX will routinely experience larger volatility and movement as compared to the S&P 500 Index. It is important to note that historically, changes in the VIX are often sudden and may be based on a variety of market, political and/or social rationales. Such shifts are normally short-lived however, with the market adjusting to such external factors. For additional information regarding the historical performance of the VIX, please click the link below the chart.
Source: Yahoo Finance VIX vs S&P 500