What is the VIX (Option Volatility Index)?
What doe the VIX Measure?
Definition of the VIX (Volatility Index):
The VIX is an indicator of the stock market's expected movement (up or down) over the next 30 days. The VIX number itself is simply the annualized expected movement (up or down) of the SandP500 Index over the next 30 days. The general media sometimes refers to the VIX as "the fear index" because lately the markets have focused on the "down" side risk of another market crash rather than the "up" side hope of a strong bull market recovery. The abbreviation "VIX" is the ticker symbol for the Market Volatility Index developed by the CBOE (Chicago Board Options Exchange).
Why is the VIX Important?
The VIX is important because it represents a measure of the amount of volatility that traders expect to see in the stock market in the short term. When the VIX goes up, it means that traders expect more volatility in the markets. Events such as the US banking crisis, the European bank crisis, threats of military action, and disruption to the oil supply create uncertainty, and therefore volatility, and drive the VIX up. When the VIX goes down, it means that the traders expect less volatility in the stock market. Events such as the Fed's quantitative easing, the European Central Banking agreeing to write off some of Greece's debt, and generally the perception of world peace restore calm to traders, and therefore drive the VIX down.
Why is the VIX Important to Options?
The VIX is important because expected volatility in the market is a key component to call option and put pricing. The more the expected volatility in the markets, the higher the prices or premiums of call and put options. The VIX is one way to gauge the amount of volatility that is priced into the market.
Read more about the significance of volatility in the prices of call and put options by reviewing the Black Scholes Option Pricing Model which is widely accepted by Wall Street as the best way to calculate the fair price of an option.
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