VIX: Volatility Index

In 1993, the Chicago Board Options Exchange (CBOE) introduced a volatility index, called VIX, based on actual index option prices and calculated this index back to the mid-1980s.

In the short run, there is a strong negative correlation between the VIX and the LEVEL of the market. When the market is falling, the VIX rises because investors are willing to pay more for downside protection. When the market is rising, the VIX typically goes down because investors become less willing to insure their portfolios against a loss.

When anxiety in the market is high, the VIX is high, and when complacency rules, the VIX is low. The peaks in the VIX corresponded to periods of extreme uncertainty and sharply lower stock prices.

In the early and middle 1990s, the VIX sank to between 10 and 20. With the onset of the Asian crises in 1997, however, the VIX moved up to a range of 20 to 30. Spikes between 50 and 60 in the VIX occurred on 3 occasions:

• when the Dow fell 550 points during the attack on the Hong Kong dollar in October 1987,
• in August 1998 when Long Term Capital Management needed to be bailed out, and,
• in the week following the terrorist attacks of September 11, 2001.

All these spikes in the VIX were excellent buying opportunities for investors. Peaks in the VIX also correspond to periods of extreme pessimism on the part of the investors. On the other hand, low levels of the VIX often reflect too much investor complacency.