Wednesday, October 1, 2008

A Note on the VIX

The VIX is a volatility index. It is a measure of the implied volatility of near term, at the money options on the S & P 500 Index. It is interpreted as a measure of market fear because the bulk of option buying is in puts (options that provide a positive return if the market moves lower). The implied volatility is the annualized standard deviation of the index used to compute the price of the option. The higher the volatility, the higher the price.

Please note that there is an upward bias to the VIX as prices move lower. For example, let's say a stock trades in a 10 cent market. As the price of the stock drops, those 10 cents become a larger portion of the stock price. Therefore, normal trading activity creates larger relative price swings.

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