Volatility and the VIX

Patrick Norwood - Insight Analyst for Funds

When looking at the history of volatility, the VIX deserves our attention. Also nicknamed 'The Fear Index' it's often mentioned in the business and financial press.

Defining the VIX

In short, the VIX is a measure of the US stockmarket’s implied volatility, or the volatility expected by the market, over the subsequent 30 days.

The VIX is calculated as a weighted blend of the prices for a range of options on the S&P 500 index. It's quoted in percentage points and translates into the expected movement in the S&P 500 over the next 30 days. This is then annualised.

Let's look at an example: If the VIX is, say, 12 points, this represents an expected annualised change - upwards or downwards - of 12% over the next month.

While the VIX refers to the US stock market alone, it can be and often is used as a proxy for markets more generally, on a global basis. That is because most other major stock markets around the world move very closely with the US market.

What to remember when using the index

It should be noted that a high VIX is not necessarily a bad sign for shares as it is a measure of perceived volatility in either direction.

Finally, the VIX is a very short-term measure of volatility and should not be used to make any investment decisions, except for short-term trading ones perhaps. When using volatility as an input into mean-variance optimisation, for example, or for any other predictions, data spanning 10 to 20 years, if not longer, should be used.