If you’re looking for a simple explanation of the VIX indicator–let me see if this helps. First, the VIX is actually called the Volatility Index and more formally–the Chicago Board Options Exchange (CBOE) Volatility Index. This is a forward-looking index that shows the market’s expectation of 30-day volatility. Because it’s a widely used measure of market risk, it has been called the gauge of investor fear. Many consider it the premier benchmark for U.S. stock market volatility.
The VIX is calculated on a real-time basis throughout each trading day. If interested in the details of the formulas, check out this document.
VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty. If there’s fear in the marketplace, the seller (of options) wants to be compensated for the additional risk. On October 24, 2008, the VIX reached an intraday high of 89.53.
Values below 20 generally correspond to less stressful times in the markets. The December 24, 2009 CBOE Volatility Index was relatively low at 19.47.
The VIX was introduced by Robert Whaley.
The VIX is discussed in a paper by Robert Whaley titled “Derivatives on Market Volatility: Hedging Tools Long Overdue,” published in the Journal of Derivatives (Fall 1993). His more recent working paper gives an updated explanation of what VIX is and is not, why it was created, what causes it to move, and why it should be an important piece to investors. You can download the paper at this link.
The first VIX, in 1993, was a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors’ expectations on future market volatility.
