The Vix Index

The Vix Index

The effects of the financial crisis of 2007-present can be measured in many different ways. It can be measured in jobs lost, the decline in portfolio values and 401K's, property value's crashing and investment sentiment at all time lows. We can see upward trends one week, and declining trends the following week, and so on. With so much uncertainty, and tomorrow's closing value of indices such as the DJI or the S&P 500 remaining ambiguous to investors worldwide, it would be of high interest to the novice investor to learn that there could be a tool to measure such volatility and ambiguity. To the same investor, it would be of even more interest to learn there is an option traded with an underlying asset being the volatility itself, with unique methods and means to be used that can both hedge investments and predict the market's movement.

To this hypothetical investor's glee, there is indeed such a "barometer of investor fear" produced by the Chicago Board Options Exchange (CBOE), dubbed the volatility index, or simply, VIX. Although given such a simple, one syllable title, investors have many different names for VIX. It's been called "the fear index" and "the fear gauge". The Financial Times has even gone as far as saying "when hedge-fund managers lie awake at night worrying about the market, the VIX index is likely to loom large." (Dash 75) To some extent, fear does play some role in the calculation of the VIX index. But the informed investor need not fear; VIX could play an important role in the hedging and trading strategies of funds large and small.

VIX was created in the late 1980's by professors Dan Galai and Menachem Brener, although later the "Galai-Brener VIX index" was introduced in a paper by Professor Robert E. Whaley. It debuted on the CBOE in 1993 as a means to measure the market's expectation of 30-day volatility implied by at-the-money S&P 100 Index option prices. (Whaley 99) In general, it is a benchmark that can be used by financial professionals to inform them of short-term market volatility. Additionally, VIX is an index upon which futures and options whose underlying asset is pure volatility can be written.

Futures and options are used as hedging tools for investors to protect themselves from unknown future occurrences in the markets. The best way to understand VIX, and the role volatility plays in general, in relation to futures and options, is to think of futures and options as insurance policies and VIX as a gauge of these policies. Homeowners purchase insurance to ensure their home's value against unfortunate events just as hedge funds purchase futures and options to ensure value against market declines. If there is an increased chance of flooding in your area, chances are more homeowners will purchase insurance. This will