“The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility.”1


In the media, the VIX is often referred to as the “fear” index. It spikes during times of crisis and market chaos. The index has a strong negative correlation to equity prices and reacts to events in other asset classes as well.

In the last decade, the VIX has evolved from an indicator to an active and liquid trading vehicle. Globally, more volatility trades through VIX-based derivative products than any other financial instrument.

Because VIX futures and options trade openly in the secondary market, the pricing of these products is transparent. This results in faster price discovery, greater liquidity, and markets that are more efficient than the volatility products that preceded them.

Investors introducing volatility into their portfolio as an asset class should understand the mechanics of VIX-based products and how to best execute multi-product vega-based strategies.

VIX futures and options












The VIX index estimates the value of a one-month variance swap on the SPX index and represents the market’s expectation of volatility over the next month. The price of the VIX is derived from the value of a basket of SPX options. It measures the risk level priced into the equity volatility market and offers distinct advantages to using at-the-money SPX volatility.

• Model independent
VIX derives its value directly from the prices of listed options on the SPX. Therefore, VIX does not depend on any model assumptions.

• Constant maturity
The VIX index always measures one-month implied volatility. As a result, it is particularly useful for comparing implied volatility regimes.

• Strike independent
The VIX index does not refer to any particular strike in the SPX but to the whole volatility surface. It allows a direct comparison between two different time periods even if the price level of the SPX is significantly different.

On any given day, VIX estimates the volatility of the next 30 calendar days, as depicted in the figure below.

















To calculate the value of the VIX index, first calculate the value of a variance swap on the SPX for both the first- and second-month expirations. Then, calculate the weighted average of these values using linear interpolation to estimate the value of 30-day variance.








If first-month SPX Var expires in 15 days and is 30 vol and second-month SPX Var expires in 45 days and is 33 vol, it follows that a weighted average of these values calculated around 30 days equals 31.5 vol.
This is the value of the VIX.

Weekend Effect

The VIX always measures implied volatility over the next 30 calendar days. However, most market volatility is realized on business days and not weekend days.

Consider that you are looking at the VIX index on a Monday (June 10). The next 30 days have 20 business days and 10 weekend days.

However, on Thursday, June 13, the next 30 days have 22 business days and 8 weekend days.

On Friday, the proportion of business days in the VIX is lowest. On Monday, the ratio of business days on the VIX index increases. Therefore, the total amount of volatility implied by the VIX – as measured over the 30 calendar days beginning on Monday – increases as well. Consequently, the VIX trends lower on Friday and higher on Mondays.


Correlation of VIX to Equity Prices
The VIX is negatively correlated to equity prices. When the prices of equities decline, typically, their implied volatility increases.

As the equity market becomes more risky, investors are likely to buy SPX options. The VIX index measures the subsequent rise in implied volatility through the increase in option premiums.

As a result, the beta of the VIX to the market is greater for large market moves. During period 1, the SPX decreased 5% and the VIX index rose by 20%. However, during period 2, a larger decline in the SPX (15%) caused an even greater increase in the VIX (140%).


Because of this sensitivity, the VIX is an effective hedging vehicle.


Unfortunately, one cannot invest directly in the VIX. The VIX index is simply a price level that references a basket of options. The components of the basket are constantly changing. Each day, the options referenced by the VIX decay and the index increases its weight toward the next month’s options. Because of time value, these options have a greater premium. However, the index does not account for the decay of rolling to these higher-priced options. As a result, any investment in a basket of options replicating the VIX would rapidly decay over time.

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