What is the Vix index?

ticker symbol $VIX for the Chicago Board Options Exchange (CBOE) Volatility Index,
which shows the market's expectation of 30-day volatility. It is
constructed using the implied volatilities of a wide range of S&P
500 index options. This volatility is meant to be forward looking and
is calculated from both calls and puts. The VIX is a widely used
measure of market risk and is often referred to as the "investor fear
gauge". There are three variations of volatility indexes: the
VIX tracks the S&P 500, the VXN tracks the Nasdaq 100 and the VXD
tracks the Dow Jones Industrial Average.The
first VIX, introduced by the CBOE 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. VIX values
greater than 30 are generally associated with a large amount
of volatility as a result of investor fear or uncertainty, while values
below 20 generally correspond to less stressful, even complacent, times
in the markets. Time for an example;Two different stocks both trading at $30.Stock A is at 30$ .We look up the march 07, $30 call option at the broker and see it trades for$ 1.25 bid $1.4 ask.We then look up stock B, also trading at $30; and see that the march 07 $30 call trades for $.90 bid $1.1 ask.Since these options will expire worthless in about 2 weeks on the 3rd Friday of March(date of sub.3/3/2007), if the stock does not trade above $30 by then,obviously investors believe that stock A has more chance of "moving" to the upside.And the pricing of the options by the market also "implies" by HOW MUCH.options with low premiums to there intrinsic value(in our example 0 since it really only has intrinsic or actual value if the stock goes above 30)imply that even if the stock moves;it will not move much.Options with high implied volatility reflect investor expectations of a big move in the price of the underlying stock.The Vix factors these expectations in.As you can see by the chart below until last week VIX had been flat and in a declining trend for years.Stock market swings like last week certainly "woke up" Mr. VIX as scared investors loaded up on "put" options and bid up the prices of these downside protecting derivitves.As of Friday the VIX index had closed around 18,a large but no means unprecedented advance from it's recent trend.
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The Chicago board Volatility index has been around since 1993,but many people don’t know of it or The potential it has for hedging your potfolio or for profit
to the left you can see a brief history of the index,but this web site will help you learn ,in simple terms,how you can use it to make money in this unpredictable market.
As
you can see from the chart, volatility soared during the Crash of 1987.
It jumped when Iraq invaded Kuwait a few years later. It jumped during
the Asian crisis in late 1997, and after the crash of the LTCM hedge
fund in 1988. It jumped up after September 11th, 2001. You get the idea
– volatility in the stock market soars after major uncertainty appears.
Ok so we know that this Volatility index is based on the amount of, and type of option buying.If investors are fearful of a market decline they will buy “put” options which allow them to either profit from a market decline,or “insure’ against a loss in a stock in there portfolio,since the “put” option will increase in value as the stock goes down in value.Conversely.Investors will buy ‘call” options when there expectations are for a market advance.But this index also factors in what is called”Implied Volatality”.since investors set the price of the various puts and calls by there bids,they can be measured by this index as relativly more or less expensive:indicating greater or lesser investor expectations of a move in the price of the underlying stock
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