Sunday 22 August 2010

The VIX Index


The volatility index produced by the Chicago Board Options Exchange, more commonly known as the VIX, shows that volatility in the markets has jumped up in the past couple of weeks. The index, often referred to as the fear index, is a weighted mix of options prices. The higher the index the higher volatility in the markets is expected to be. As market volatility increases or expectations of market volatility increase options prices rise. This is due to an options price being a function of volatility in the underlying asset. If the underlying asset is expected to be more volatile the corresponding options contract has a higher probability of being in the money so the price is higher.

Even though the index has risen over the past couple of weeks it is still trading within its recent down trend. The current level is in the range at which the VIX was trading in the one and a half years prior to the collapse of Lehman’s. The recent turmoil seen over the past couple of months in the markets saw a severe spike, a mini 2008, but now it appears to be trending back down after this spike. If a double dip recession happens, as some people believe it will, and the markets crash again the VIX will break its trend on the upside and trade higher. If the uptrend seen in the past couple of weeks continues and moves out above 30 it may be an indicator that investor’s beliefs in a double dip are widening.

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