CBOE VOLATILITY INDEX (VIX)
APPLICABLE TIME FRAME(S):
SHORT / INTERMEDIATE
UPDATE SCHEDULE:
Each weekday night by 7:00 PM EST
RECENT STUDIES:
11/13/12 - No jump in fear despite a lower market
11/06/12 - VIX futures are in backwardation
10/22/12 - The VIX reversal suggests a buy signal for stocks
10/17/12......Options traders are betting that the VIX "fear gauge" is about to rise
09/10/12......According To The VIX, Fear Jumped 10% The Day After A New High In The S&P 500
09/04/12......The VIX "Fear Gauge" Has Risen 9 Out Of 11 Days, While The S&P 500 Barely Moved
08/29/12......The VIX Has Risen 25% During A Time The S&P 500 Has Declined Less Than 1%
08/24/12......VIX Futures Traders Are Pricing In Higher Volatility - But Not Extremely So
07/23/12......The VIX Has Jumped 20% In Two Days
07/11/12......The S&P Has Dropped For 5 Straight Days, But The VIX Is Up Less Than Half Usual
05/15/12......VIX Crosses Above Its Six-Month Average For First Time In 100 Days
05/01/12......Real, Historical Volatility Is Close To Exceeding Implied Volatility (VIX)
04/09/12......The VIX Has Risen For 7 Straight Days; The McClellan Oscillator Is Grossly Oversold
02/09/12......The VIX Rises Along With The S&P 500; Corporate Insider Selling Picks Up
01/10/12......OEX Put/Call Ratio vs Equity Put/Call Ratio; CS Fear Barometer vs The VIX
01/06/12......Unfilled Gap Bodes Well; Seasonality Does Not, Especially With The VIX This Low
EXPLANATION:
The VIX measures the implied volatility (i.e. estimated future volatility) of near-term at-the-money SPX (S&P 500) index options (click here for an excellent overview of options by the CBOE).
If the SPX moves significantly, new strike prices are used to calculate the VIX. Since there is a skew to options prices and implied volatility changes with the strikes, the VIX will typically rise when the market drops and fall when the market rises. This is not always the case, but the correlation is clear.
The common interpretation of VIX movements is that the VIX will rise when fear or uncertainty does, since there will be a greater demand for put options. Conversely, when the market is rising, that typically creates complacency on the part of traders and the VIX will fall as the demand for put options decreases.
GUIDELINES:
Instead of being focused on the absolute level of the VIX, we prefer to use Bollinger Bands to define our extremes, which shows us how extreme the VIX is compared to its average over the past quarter. If the VIX goes outside of one of the bands, we know that it is two standard deviations away from its mean value of the past three months - truly an extreme event - any usually a precursor to a market reversal.
We also include a measure of the "volatility of volatility", which is a 21-day historical volatility of the VIX itself. Looking at the data this way can often give us more accurate signals than watching the VIX, as it tells us how quick traders are to change their opinions of future volatility.
When they see no need to change their outlook, then we might assume that they are becoming complacent. In that case, the historical volatility of the VIX will contract (i.e. the indicator on the bottom pane of the chart will exceed the red trading bands), and often a market decline will follow.
ADDITIONAL RESOURCES:
Chicago Board Options Exchange (www.cboe.com)
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