Overview of the CBOE Volatility Index: VIX
Table Of Contents:
Introduction 4
Methodology 5
Uses of VIX 12
Investor Fear Gauge: 12
Hedging with VIX: 13
Hedging with VIX Options and Futures: 15
Risk management case study application: 16
Conclusion: 20
Bibliography: 21 Introduction
The VIX is the ticker symbol for the volatility index that the Chicago Board Options Exchange (CBOE) created to measure the implied volatility of options on the S&P 500 index (SPX) over the next 30 calendar days. The formal name of the VIX is the CBOE Volatility Index. Originally, it was pioneered by Professor Robert Whaley in 1993. In the same year CBOE introduced Volatility Index that measured market’s expectation of 30 day volatility implied by eight at-the money S&P 100 (OEX) put and call option prices. Throughout a decade VIX gained popularity and recognition in the capital market especially in the US. In 2003, CBOE together with Goldman Sachs reviewed and updated VIX which is based on a broader index S&P 500 (SPX) one of the main indexes of U.S. equities. The new VIX estimates the expected volatility for next 30 days by averaging weighed price of SPX puts and calls option over wide range of strike price. VIX is commonly referred as Fear Gauge or Fear Index because it is said to be a good indicator of the level of fear and greed of investors in the U.S. on the equity market. When there is a fear among investors, the VIX level is notably higher than normal. The ratio of VIX to S&P 500 during our economic crisis of 2008 clearly underlines this property as demonstrated in graph 1. This strong negative correlation will be examined later in the report and brings the second use of this product, hedging. (CBOE, 2009)
Graph 1: Today VIX has established itself from abstract concept to standard use that many market participants find it practical. CBOE introduced the first exchange-traded VIX futures contract in March 24, 2004. After two years time, CBOE also launched VIX options. These financial products are very
Introduction 4
Methodology 5
Uses of VIX 12
Investor Fear Gauge: 12
Hedging with VIX: 13
Hedging with VIX Options and Futures: 15
Risk management case study application: 16
Conclusion: 20
Bibliography: 21 Introduction
The VIX is the ticker symbol for the volatility index that the Chicago Board Options Exchange (CBOE) created to measure the implied volatility of options on the S&P 500 index (SPX) over the next 30 calendar days. The formal name of the VIX is the CBOE Volatility Index. Originally, it was pioneered by Professor Robert Whaley in 1993. In the same year CBOE introduced Volatility Index that measured market’s expectation of 30 day volatility implied by eight at-the money S&P 100 (OEX) put and call option prices. Throughout a decade VIX gained popularity and recognition in the capital market especially in the US. In 2003, CBOE together with Goldman Sachs reviewed and updated VIX which is based on a broader index S&P 500 (SPX) one of the main indexes of U.S. equities. The new VIX estimates the expected volatility for next 30 days by averaging weighed price of SPX puts and calls option over wide range of strike price. VIX is commonly referred as Fear Gauge or Fear Index because it is said to be a good indicator of the level of fear and greed of investors in the U.S. on the equity market. When there is a fear among investors, the VIX level is notably higher than normal. The ratio of VIX to S&P 500 during our economic crisis of 2008 clearly underlines this property as demonstrated in graph 1. This strong negative correlation will be examined later in the report and brings the second use of this product, hedging. (CBOE, 2009)
Graph 1: Today VIX has established itself from abstract concept to standard use that many market participants find it practical. CBOE introduced the first exchange-traded VIX futures contract in March 24, 2004. After two years time, CBOE also launched VIX options. These financial products are very
Bibliography: Web source: Brenner M. (2001). Hedging Volatility Risk. Available at: http://www.globalriskguard.com/resources/deriv/hedge_volat_risk.pdf Accessed date: 27/04/2011 CBOE. (2009). The CBOE Volatility Index – VIX Available at: http://www.cboe.com/micro/vix/vixwhite.pdf Acessed date: 26/04/2011 Dennis P, Mayhew S, Stivers C. (2005). Stock Returns, Implied Volatility Innovations, and the Asymmetric Volatility Phenomenon. Available at: http://gates.comm.virginia.edu/pjd9v/paper_comove.pdf Accessed date: 05/05/2011 Dong G. (2007). Improving Risk-Adjusted Returns of Fixed-Portfolios with VIX Derivatives. Available at: http://pegasus.rutgers.edu/~gangdong/docs/VIX.pdf Accessed date: 04/05/2011 Dong G. (2011). Pricing the Futures of Volatility Index. Available at: http://pegasus.rutgers.edu/~gangdong/docs/VIX.pdf Accessed date: 27/04/2011 Hull, J.C., (2009). Options, Futures, and other Derivatives. 7th edition. New Jersey: Pearson Prentice Hall. Standard & Poor’s (2008). S&P 500 VIX Futures Index Series. Available at: http://www2.standardandpoors.com/spf/pdf/index/SP_500_VIX_Futures_Index_Series_Factsheet.pdf Accessed date: 01/05/2011 Standard & Poor’s (2009). Directional Exposure to Volatility Via Listed Futures. Available at: http://www2.standardandpoors.com/spf/pdf/index/SP_500_VIX-ShortTermFutures_WhitePaper.pdf Accessed date: 04/05/2011 Whaley, R.(2008). Understanding VIX. Available at: http://ssrn.com/abstract=1296743 Accessed date: 01/05/2011