## The VIX Index explained

The **Cboe***** Volatility Index**, more commonly known as the **VIX Index** or simply “**the VIX**“, is an indicator of the **annualized 30-day expected S&P500 Index volatility** and is used as an overall benchmark for volatility in the U.S. stock market.

It is the implied volatility and is calculated in real-time from the midpoint prices (bid/ask quote) of S&P 500 Index (SPX) out-of-the-money call and put options with near-term expiration dates.

The VIX Index provides a quantifiable measure of market risk and investors’ sentiments. Therefore, investors and traders use the VIX Index as a **gauge of market sentiment**.

The nick name is the “**Fear Index**” or “**Fear Gauge**” because usually the **VIX Index rises when the stock market falls** (= more fear and uncertainty), and conversely, the** VIX Index will fall when the stock market rises** (= less fear). Typically, there is an inverse relationship with the S&P 500 Index.

### How to interpret the value of the VIX Index?

The VIX Index is expressed in **percentage** terms of an **annualized one standard deviation** of returns of the S&P 500 Index. Because it is a percentage the price is limited between 0 and 100.

From statistics, we know that for a standard normal distribution:

- 68% of the observations lie within 1 standard deviation of the mean
- 95% lie within 2 standard deviations of the mean
- 99.7% lie within 3 standard deviations of the mean

This means theoretically that if the VIX Index equals 15, for example, the market expectations over the next 12 months are as follows:

- 68% probability that the return will be between +15% and -15%
- 95% probability that the return will be between +30% and -30%
- 99.7% probability that the return will be between +45% and -45%

### How to calculate the monthly market volatility?

To convert the VIX Index (the annualized volatility) to a monthly volatility, divide the VIX by √ 12 *(divide by the square root of 12 because there are 12 months in a year)*.

Assume again that VIX equals 15, this gives a calculated monthly volatility of 4.33 % (because 15 / √ 12 = 4.33). A monthly volatility of 4.33 % means that the expected return for the S&P500 index over the next 30-days is:

- 68% probability that the return will be between +4.33% and -4.33%
- 95% probability that the return will be between +8.66% and -8.66%
- 99.7% probability that the return will be between +12.99% and -12.99%

### How to calculate the daily market volatility?

To convert the VIX Index (the annualized volatility) to a daily volatility, divide the VIX by √ 252 *(divide by the square root of 252 because there are 252 trading days per year)*.

Notice that the square root √ 252 = 15.87 or approximately 16. Therefore, traders divide the annual volatility by 16 to easily calculate the daily volatility. This is called the “volatility rule of 16“.

Assume again that VIX equals 15, this gives a calculated daily volatility of 0.94 % (because 15 / 16 = 0.94). A daily volatility of 0.94 % means that the expected return for the S&P500 index in one trading day is:

- 68% probability that the return will be between +0.94% and -0.94%
- 95% probability that the return will be between +1.88% and -1.88%
- 99.7% probability that the return will be between +2.82% and -2.82%

### How to read the VIX and market sentiment?

The VIX provides valuable stock market information about investor sentiment that can be helpful for traders and investors. Generally:

- 12 or lower: means low volatility and usually a rising market
- between 13 and 19: this range is
**normal volatility** - 20 or higher: means high volatility and usually fear and a falling market

### Can I trade the VIX Index?

The VIX Index is not directly tradable but indirectly with VIX futures, VIX options, and VIX ETFs or VIX ETNs.

VIX futures began trading on March 26, 2004, and VIX options followed on February 24, 2006.

**Cboe = Chicago Board Options Exchange*

## Summary

- The VIX Index is a forward-looking indicator
- Calculated in real-time using S&P500 Index option prices
- The level suggests the degree of market uncertainty
- Only indirectly tradable with VIX futures, VIX options, and VIX ETFs / VIX ETNs