VIX Explained: Demystifying the Stock Market’s “Fear Index”

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During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, and Carroll discussed VIX Explained: Demystifying the Stock Market’s “Fear Index”. Here’s an excerpt from the episode:

Tobias: Jim, you sent me a through. You did a review of what happened in the VIX and volatility last year. Let’s start there. Why don’t we just start off at a very rudimentary level? Let’s talk about first what volatility VIX is, and then let’s proceed into it from there, if you don’t mind.

Jim: Sure. No, not at all. So VIX is a measure of S &P 500 implied volatility going out 30 days, so it’s looking out 30 days into the future, and it’s essentially taking a strip of S&P 500 index options, both puts and calls and measuring the implied volatility of those options and then collapsing that into one number or VIX.

And what people colloquially know about VIX is that it is the fear index. VIX jumps when things get bad, and VIX tends to drop when things are calm. It’s a little more nuanced than that. There’s kind of an ecosystem that has been built up around VIX. VIX goes back to about 1993. It’s gone through a couple of computation changes to kind of keep up with the modern world, but what people think about when they think about VIX is fear and what’s happening in the market, is it calm? Is everything okay? Or is it agitated? And things are maybe upside down.

It’s become even more complicated over time because somebody said, “Well, gee, if we have a 30-day measure of implied volatility, why don’t we have a 60-day measure of implied volatility? Why don’t we go out three months and six months and a year.” And you can actually create a term structure of volatility from these different [unintelligible 00:02:47] indices. And now we’ve gone all the way down to zero, because obviously, zero day to expiration options are all the rage these days. So, we’ve created this ecosystem.

And another part of that, another important part of that, going back to 2004, was the introduction of VIX futures. So, we have an array of VIX futures and then VIX options that actually trade to the futures, not to the spot index. So, there’s a lot to get confused about, and people are routinely confused about what to do with these things and why is this one going one direction and that one’s going a different direction and so it makes life fun for me on Twitter because I can jump in and try to confuse people even more.

Tobias: [Laughs]

Jake: If Jim it is a zero day, does that– You know we’ve heard about how that has this gamma issues for regular stocks, but does that do anything to the VIX side as well?

Jim: Well, there’s been a lot of–

Jake: Hedging.

Jim: Yeah, there’s been a lot of back and forth on that in the Vol Twit, if you will because if you think about it–

Jake: [crosstalk]

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