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# The VIX

The Chicago Board Options Exchange’s Volatility Indexor VIXis based on option prices on the S&P 500 stock index.

• It attempts to quantify investors’ expectation of stock market (S&P 500) volatility over the next 30 days. It is then quoted as an annualized standard deviation.

• The VIX is commonly referred to as the market’s ‘fear gauge’.

## Interpreting the VIX

Say the VIX is presently 10. This means there is about a 68% chance (one standard deviation) that the absolute value of the market’s return will be less than \frac{10}{\sqrt{12}} = 2.89 over the next 30 days (one month).

• We divide by \sqrt{12} to convert from the annualized volatility (in which VIX is quoted) into the monthly volatility.

## The VIX and the Stock Market

The VIX and the stock market tend to move in opposite directions.

• In finance, this is known as the leverage effect.

You can see this effect in the following slide, which plots the S&P 500 index and the VIX.

• The VIX is highest when the market (S&P 500) experiences large losses.

• You can select subintervals by clicking and dragging on the chart.

## The VIX is Forward Looking

The VIX reflects market expectations of future volatility. A measure like the standard deviation of historical data, on the other hand, looks only at what has already happened.

• This distinction is very important if, say, there is a Federal Reserve announcement over the next month. Fed anouncements can cause substantial volatility, and so this expected volatility will be priced into the VIX (that is, the VIX will be high).

• However, if there are no important announcements over the next month, the VIX will be relatively low.

## VIX, Market Return, and Volume

The following app shows how expected market volatility (VIX) is related to market returns and volume. Volume is in billions of U.S. dollars.

• You can see that large positive market returns coincide with large negative changes in the VIX and heavy volume. Similarly, large negative market returns coincides with large increases in the VIX and also heavy volume.

• Volume is generally lower for middling returns and minor changes in the VIX.

• Points of similar color denote similar points in time (though the red is recycled somewhat). This allows you to see the effect of volume and volatility clusteringthis is the observation that if the market is volatile with heavy volume today, it will tend to be volatile with heavy volume tomorrow, and similarly for non-volatile and low-volume periods.

## Credits and Collaboration

Click the following links to see the codeline-by-line contributions to this presentation, and all the collaborators who have contributed to 5-Minute Finance via GitHub.