 |
| Image: Moneybestpal.com |
VIX is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options. The Chicago Board Options Exchange (CBOE) calculates and publishes it. Because it tends to increase when investors are concerned about the direction of the market, VIX is occasionally referred to as the "fear index."
The S&P 500 index, a widely used benchmark of American stocks, provides the basis for VIX's option prices. Contracts known as options grant buyers the right, but not the duty, to purchase or sell an underlying asset at a given price and time. The current value of the underlying asset, the option's strike price, the duration until expiration, and the volatility of the underlying asset are some of the variables that affect an option's pricing.
Volatility is a gauge of how much an asset's price changes over time. It depicts the asset's risk and degree of uncertainty. Higher risk and potential returns are associated with higher volatility, but so are higher option prices. Lower volatility not only translates to lower options pricing but also lower risk and potential gains.
VIX is derived from a formula that estimates how much volatility investors expect over the next 30 days, based on the prices of near-term S&P 500 options. A high VIX score means investors anticipate considerable volatility in the near term, which suggests increased apprehension and uncertainty in the market. A low VIX score suggests that investors anticipate little volatility in the near term, which suggests increased market confidence and calm.
The VIX is frequently employed as a portfolio hedging and diversification tool as well as a measure of market mood. Investors can utilize the VIX to determine the market's risk and opportunity levels and to modify their exposure as necessary. For instance, when the VIX is high, investors might hold fewer stocks and keep more cash or bonds, or they might buy protective options like puts or calls to hedge against potential losses. Investors may buy more stocks, sell less cash or bonds, or sell options to increase returns or create income when the VIX is low.
Various financial products, including futures, options, exchange-traded funds (ETFs), and exchange-traded notes (ETNs), all use VIX as an underlying asset. Depending on their goals and strategies, investors can trade VIX directly or indirectly using these products. For instance, some investors might speculate on volatility changes or utilize VIX futures or options to hedge against volatility risk. To acquire exposure to volatility without dealing with futures or options contracts, some investors may use VIX ETFs or ETNs.
Despite not being a perfect predictor of future volatility or market movements, VIX is a significant indicator of market psychology and behavior. The implied volatility based on option prices is the only facet of volatility that the VIX measures. Other types of volatility, such as historical volatility based on past price changes, realized volatility based on actual price changes, and intrinsic volatility based on fundamental causes, are not included. Furthermore, the options market's supply and demand dynamics, which might not always reflect investors' actual expectations, have an impact on VIX.
As a result, while making financial decisions, VIX should be utilized cautiously and in conjunction with other indicators and tools. VIX is part of a thorough study of market circumstances and opportunity rather than a stand-alone indicator of risk or return.
