VIX is the symbol for the Chicago Board Options Exchange’s (CBOE) volatility index for the S&P 500 (SPX). It is a measure of the level of implied volatility (what traders expectations for volatilty are) and not historical or statistical volatility. A numerical value for the VIX has been published by the CBOE since 1993. A high VIX number means high implied volatility, whereas a low VIX number means lower implied volatility. The method of calculating VIX was changed in early 2003 to become more representative of the broader market. Instead of using the S&P 100 (OEX) Index options, it is now calculated using the options on the S&P 500 (SPX). Also note that the VXN is the symbol for the implied volatility index of the NASDAQ 100 index.
The implied volatilities are weighted to give the VIX a value that in effect acts as the implied volatility of an at-the-money SPX option at 22-trading days to expiration. The VIX represents the implied volatility of a hypothetical at-the-money SPX option. If implied volatility is high, the premium on options will be high and vice versa. Generally speaking, rising option premiums reflect rising expectation of future volatility of the underlying stock index, which represents higher implied volatility levels. The higher the VIX, the more panic in the markets and the greater the chance that investors have given up hope, taken their money, and gone home.
Comparing the movement of the VIX with that of the market can quite often provide clues as to the future direction the market might move. The more the VIX increases in value, the more “panic” is an issue in the market place. On the flip side, the more the VIX decreases in value, the more complacency there is amongst investors. The psychological impact measured by a relatively high VIX is a clear indicator that tells traders markets are oversold. At its core, the VIX is a statistical measure of emotions, and emotions are a major factor signalling capitulation in the market.