Do You Know How to Trade the VIX?

Here's a primer on the VIX products

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Do You Know How to Trade the VIX?

CBOE Volatility Index (VIX)

vix1 Do You Know How to Trade the VIX?

The CBOE Volatility Index (CBOE:VIX) is essentially the “New Coke” to VXO’s “Original Formula.”

Here’s the quick description of the two big changes to the VIX methodology, straight from the CBOE’s mouth in 2003:

1. Based on S&P 500 Options Prices

“The new VIX will be based on prices of S&P 500 (SPX) options … Previously, the original-formula VIX was based on prices of the S&P 100 Index Options (CBOE:OEX), and CBOE will continue to calculate and disseminate the original-formula index to be known as the CBOE S&P 100 Volatility Index with the ticker VXO.”

2. New Formula for Calculation of VIX

“The new formula that will take into account a broader range of strike prices (rather than using only near-the-money strikes as the original-formula index did). Each strike price will be weighted, with at-the-money strikes having the most weight. The new formula is intended to make VIX a better index for investors who manage risks associated with the growing markets for volatility and variance swaps.”

Essentially, VIX incorporates all sorts of out-of-the-money (OTM) puts not included in VXO, so the ratio between the two yields clues to OTM put demand and skew.

Always remember that the VIX itself is a STATISTIC. No one buys and sells the actual VIX at actual prices. It doesn’t print. It opens when SPX options open and a value for VIX is first calculated.

Article printed from InvestorPlace Media,

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