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What is the 'VIX - CBOE Volatility Index'

The Volatility Index, or VIX, is an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options. This volatility is meant to be forward looking, is calculated from both calls and puts, and is a widely used measure of market risk. The VIX is often referred to as the "investor fear gauge."

Fear, volatility, and the index move up when stock prices are falling and investors are fearful. The index, volatility, and fear decline when stock prices are rising.

Breaking Down 'VIX - CBOE Volatility Index'

The Volatility Index (VIX) lead to two other volatility indexes being created. The VXN, which tracks the NASDAQ 100. The VXD, which tracks the Dow Jones Industrial Average (DJIA).

The VIX, however, was the first successful attempt at creating and implementing a volatility index. Introduced in 1993, it was originally a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, in 2004, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors' expectations on future market volatility.

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.

How the VIX's Value Is Established

The VIX is a computed index, much like the S&P 500 itself, although it is not derived based on stock prices. Instead, it uses the price of options on the S&P 500, and then estimates how volatile those options will be between the current date and the option's expiration date. The CBOE combines the price of multiple options and derives an aggregate value of volatility, which the index tracks.

The CBOE offers VIX options and VIX futures to trade. Additionally, there are many volatility exchange-traded products (ETPs). One of the most popular, in terms of daily volume, is the iPath S&P 500 VIX Short-Term Futures ETN (VXX).

An Example of the VIX

Movements of the VIX are largely dependent on stock market reactions. When stock prices fall, the VIX will spike. The VIX typically moves much more than the stocks. For example, if stocks fall 3% in one day, the VIX may rise 15% or more.

S&P 500 chart versus VIX chart.

The chart above shows how the S&P 500 and VIX interact. The moves in VIX can be severe, especially if a stock sell-off occurs when the VIX is at very low levels, such as below 15. The sell-off in February saw the S&P 500 decline just under 12%. The VIX, during that time, rallied more than 350% before quickly pulling back once the stock market stabilized again. The S&P 500 decline in March was less shocking to investors; the VIX moved up but much more conservatively, showing fear was at a much lower level relative to February.

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