The CBOE S&P 500 Volatility Index (VIX), often referred to as the “Fear Index,” serves as a valuable indicator of traders' concerns regarding a potential sudden decline in the S&P 500 within the next 30 days. When the VIX rises, it signals increasing nervousness among traders, while a declining VIX indicates growing confidence.

The VIX is a real-time index that reflects the market's expectations for future stock market volatility. Its full name is the Chicago Board of Options Exchange Market Volatility Index (VIX). In technical terms, volatility measures the standard deviation of historical market prices. In simpler terms, it refers to the extent of price fluctuations over time.

A volatility index quantifies the likelihood of sudden, unexpected price movements in a specific market, indicating its relative instability. The VIX measures implied volatility based on the prices of a selection of S&P 500 Index options that are set to expire in 30 days. It is also known by other names such as the “Fear Gauge” or “Fear Index.” The VIX is the most recognized volatility index in the market and is frequently utilized by stock and options traders to assess the level of market anxiety.

What is the VIX? The CBOE Volatility Index, or VIX, is the most prominent tool for trading financial market volatility. It gauges the expected 30-day volatility of the U.S. stock market based on S&P 500 options. Essentially, it mathematically estimates how much the market anticipates the S&P 500 Index option (SPX) will fluctuate over the next 12 months, derived from the analysis of the differences between current SPX put and call option prices.

Although the VIX is not expressed as a percentage, it should be interpreted as one. For instance, a VIX reading of 30 implies an expected volatility of 30% for the SPX. This indicates a 66.7% probability (or within one standard deviation) that the index will trade within a range that is 30% higher or lower than its current level over the next year. In practical terms, if the S&P 500 is trading at 3,000, the VIX suggests that over the next 12 months, its price could fluctuate between 2,100 and 3,900 (30% below and above 3,000), with a 66.7% probability of remaining within this range.

The VIX tends to rise when there is an increase in put option buying and falls when call option buying is more prevalent. A call option gives the holder the right (but not the obligation) to purchase a specified quantity of stock at a predetermined price within a set timeframe. Conversely, a put option grants the holder the right (but not the obligation) to sell a specified quantity of stock at a predetermined price within a fixed period.

What is Volatility? Volatility measures how frequently and significantly the price of a financial instrument changes, both upwards and downwards, over a specific timeframe. Greater price swings indicate higher volatility. This can be assessed using actual historical price changes (realized volatility) or by evaluating expected future volatility as implied by option prices. The VIX Index specifically measures expected future volatility.

How is the VIX Calculated? The VIX Index estimates expected volatility by aggregating the weighted prices of S&P 500 Index (SPXSM) puts and calls across a broad range of strike prices. The prices used for calculating VIX Index values are the midpoints of real-time SPX option bid/ask price quotations.

How is VIX Used? The VIX Index acts as a barometer for market uncertainty, offering market participants and observers a measure of the expected 30-day volatility of the broader U.S. stock market. An increasing VIX suggests that traders anticipate greater volatility in the S&P 500 Index. A VIX value above 30 indicates a volatile market, while a value below 20 suggests calmness. Higher VIX readings correlate with increased fear, and for contrarians, high values can be seen as bullish. Conversely, a declining VIX indicates that traders expect the S&P 500 Index to trade more quietly, with lower VIX values reflecting reduced fear and a more complacent market. For contrarians, consistently low readings can be interpreted as bearish.

When and Where does the VIX trade? The VIX Index is not directly tradable; however, its methodology allows for replicating volatility exposure through a portfolio of SPX options, leading to the development of tradable VIX futures and options. The VIX Index is calculated and disseminated overnight, providing real-time volatility information to market participants whenever news breaks. The Chicago Board Options Exchange introduced the VIX in 1993, during regular trading hours from 9:30 a.m. to 4:15 p.m. ET. In 2016, the CBOE extended the index's availability outside U.S. trading hours, from 3 a.m. to 9:15 a.m. ET. Monthly and weekly expirations for VIX options are available and trade during U.S. regular trading hours, as well as during a limited global trading hours session. Several ETFs (Exchange Traded Funds) that track the VIX include VXX, VIXY, and VIIX.