The Chicago Board Options Exchange (CBOE) calculates a real-time index to show the expected level of price fluctuation in the S&P 500 Index options over the next 12 months. Officially called the CBOE Volatility Index and listed under the ticker symbol VIX, investors and analysts sometimes refer to it by its unofficial nickname: the fear index.
Technically speaking, the CBOE Volatility Index does not measure the same kind of volatility as most other indicators. Volatility is the level of price fluctuations that can be observed by looking at past data. Instead, the VIX looks at expectations of future volatility, also known as implied volatility. Times of greater uncertainty (more expected future volatility) result in higher VIX values, while less anxious times correspond with lower values.
The initial VIX was released by the CBOE in 1993. At the time, the index only took into consideration the implied volatility of eight separate S&P 100 put and call options. Following 2002, the CBOE made the decision to expand the VIX to the S&P 500 in order to better capture market sentiment. VIX futures were added in 2004 and VIX options followed in 2006.
VIX values are quoted in percentage points and are supposed to predict the stock price movement in the S&P 500 over the following 30 days. This value is then annualized to cover the upcoming 12-month period. The VIX formula is calculated as the square root of the par variance swap rate over those first 30 days, also known as the risk-neutral expectation. This formula was developed by Vanderbilt University Professor Robert Whaley in 1992.
Investors, analysts and portfolio managers look to the CBOE Volatility Index as a way to measure market stress before they make decisions. When VIX returns are higher, market participants are more likely to pursue investment strategies with lower risk.