Volatility index, also known as the VIX, is a financial metric that measures the degree of fluctuations in the prices of stocks or other financial assets. The VIX is often referred to as the “fear index” because it typically rises during times of market uncertainty and volatility.
The VIX was created in 1993 by the Chicago Board Options Exchange (CBOE) as a way to measure the market’s expectation of 30-day volatility. It is calculated using the prices of put and call options on the S&P 500, which is a benchmark index of 500 of the largest publicly traded companies in the United States.
Put options give the holder the right to sell a stock at a specific price within a certain time frame, while call options give the holder the right to buy a stock at a specific price within a certain time frame. When investors buy put options, they are usually hedging against a decline in the stock market, while investors buying call options are typically expecting a rise in the market.
The VIX measures the cost of these options and indicates the expected volatility of the market. A high VIX reading indicates that investors are anticipating significant price swings in the stock market, while a low VIX reading suggests that investors are expecting the market to be stable.
Investors use the VIX as a gauge of market sentiment and risk, and it is often used to hedge portfolios against volatility. For example, if an investor believes that the market is about to experience significant volatility, they may buy put options on the S&P 500 to protect their portfolio from potential losses.
The VIX is also used by traders as a trading tool, as they can use it to determine the appropriate levels of risk and reward for their trades. High VIX readings can indicate an opportunity to enter short positions, while low VIX readings can indicate a good time to enter long positions.
While the VIX is primarily used to measure volatility in the stock market, it can also be used to measure volatility in other financial markets, such as commodities and currencies. The CBOE has also created other volatility indexes, such as the VIX futures and the VIX options, which allow investors to trade on the expected volatility of the market.
In conclusion, the volatility index, or VIX, is a financial metric that measures the degree of fluctuations in the prices of stocks or other financial assets. The VIX is calculated using the prices of put and call options on the S&P 500, and it is often used as a gauge of market sentiment and risk. Traders and investors use the VIX to determine appropriate levels of risk and reward for their trades and to hedge against market volatility.