Feb 6, 2018

3 questions about the CBOE Volatility Index (VIX), answered

Data: Money.net; Chart: Axios Visuals

Credit Suisse announced the last day of trading for volatility-related security XIV would be Feb. 20, reports CNBC. Trading was halted Tuesday morning after the security plunged 85% in aftermarket hours.

Why it matters: Near-record volatility can have implications far beyond what happens to individual stocks, wiping out investments that had been viewed as safe just days ago.

What is implied volatility?

Implied volatility (IV) is a forward-looking, subjective tool that measures the expected variations in the price of a security. IV generally increases when investors believe a security's price will fall over time and decreases when the price is expected to rise.

IV is an estimate of future prices that is based on probability, meaning that there is no guarantee a security's price will follow a predicted outcome. Its utility stems from its correlation with market opinion, which has a direct impact on how options are priced. It's also important to note that IV does not predict the direction of a price fluctuation. High volatility indicates a large price swing, but does not indicate whether that swing will be up, down or both.

What is the VIX?

The Chicago Board Options Exchange (CBOE) introduced the VIX in 1993 as a measure of the 30-day implied volatility of eight S&P 100 options. Today, the VIX is a computed index that aggregates the volatility of options prices on the S&P 500, and is widely considered "the premier benchmark for U.S. stock market volatility," or "investor fear gauge," according to CBOE.

The VIX began offering futures contracts in 2004, allowing investors to bet on the expected volatility of the S&P over the next 30 days. VIX values greater than 30 are generally associated with high market volatility, while values lower than 20 tend to indicate a calmer market.

What is its impact on the market?

Per Axios' Dan Primack, the VIX volatility index yesterday spiked in a way we've only seen three other times since it was created in 1993:

1999 dotcom crash
2009 credit crisis
2011 fears over debt ceiling vote

... and then it went even higher in the aftermarket. Several exchange-traded notes inversely related to the VIX, including XIV, have experienced a free fall as volatility spikes. Some fear that Credit Suisse and other volatility-related issuers' move to liquidate their funds will further drive up the VIX and trigger another big equity sell-off.

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