VIX , OIL VIX

article dated: April 29, 2008
Ten Things Everyone Should Know About the VIX

Both measures tend to rise when the underlying value they track falls. The VIX tracks the Standard & Poor's 500, while the Oil VIX tracks the United States Oil Fund ETF (AMEX: USO).

I have had quite a few requests to present some introductory material on the VIX, so with that in mind I offer up the following in question and answer format:

Q: What is the VIX?
A: In brief, the VIX is the ticker symbol for the volatility index that the Chicago Board Options Exchange (CBOE) uses to calculate the implied volatility of options on the S&P 500 index (SPX) for the next 30 days. The formal name of the VIX is the CBOE Volatility Index.

Q: How is the VIX calculated?
A: The CBOE utilizes a wide variety of strike prices for SPX puts and calls to calculate the VIX. In order to arrive at a 30 day implied volatility value, the calculation blends options expiring on two different dates, with the result being an interpolated implied volatility number. For the record, the CBOE does not use the Black-Scholes option pricing model. Details of the VIX calculations are available from the CBOE in their VIX white paper.

Q: Why should I care about the VIX?
A: There are several reasons to pay attention to the VIX. Most investors who monitor the VIX do so because it provides important information about investor sentiment that can be helpful in evaluating potential market turning points. A smaller group of investors use VIX options and VIX futures to hedge their portfolios; other investors use those same options and futures to speculate on the future direction of the market.

Q: What is the history of the VIX?
A: The VIX was originally launched in 1993, with a slightly different calculation than the one that is currently employed. The ‘original VIX’ (which is still tracked under the ticker VXO) differs from the current VIX in two main respects: it is based on the S&P 100 (OEX) instead of the S&P 500; and it targets at the money options instead of the broad range of strikes utilized by the VIX. The current VIX was reformulated on September 22, 2003, at which time the original VIX was assigned the VXO ticker. VIX futures began trading on March 26, 2004 and VIX options followed on February 24, 2006.

Q: Why is the VIX sometimes called the “fear index”?
A: The CBOE has actively encouraged the use of the VIX as a tool for measuring investor fear in their marketing of the VIX and VIX-related products. As the CBOE puts it, “since volatility often signifies financial turmoil, [the] VIX is often referred to as the ‘investor fear gauge’”. The media has been quick to latch onto the headline value of the VIX as a fear indicator and has helped to reinforce the relationship between the VIX and investor fear.

Q: How does the VIX differ from other measures of volatility?
A: The VIX is the most widely known of a number of volatility indices. The CBOE alone recognizes nine volatility indices, the most popular of which are the VIX, the VXO, the VXN (for the NASDAQ-100 index), and the RVX (for the Russell 2000 small cap index). In addition to volatility indices for US equities, there are volatility indices for foreign equities (VDAX, VSTOXX, VSMI, VX1, MVX, VAEX, VBEL, VCAC, etc.) as well as lesser known volatility indices for other asset classes such as oil, gold and currencies.

Q: What are normal, high and low readings for the VIX?
A: This question is more complicated than it sounds, because some people focus on absolute VIX numbers and some people focus on relative VIX numbers. On an absolute basis, looking at a VIX as reformulated in 2003, but using data reverse engineered going back to 1990, the mean is a little bit over 20, the high is just below 90 and the low is just below 10. Just for fun, using the VXO (original VIX formulation), it is possible to calculate that the VXO peaked at about 172 on Black Monday, October 19, 1987.

Q: Can I trade the VIX?
A: At this time it is not possible to trade the cash or spot VIX directly. The only way to take a position on the VIX is through the use of VIX options and futures. On 1/30/09, Barclays Capital launched two new VIX ETNs that are based on VIX futures: VXX, which targets VIX futures with 1 month to maturity; and VXZ, which targets 5 months to maturity.

Q: How can the VIX be used as a hedge?
A: The VIX is appropriate as a hedging tool because it has a strong negative correlation to the SPX – and is generally about four times more volatile. For this reason, portfolio managers often find that buying of out of the money calls on the VIX to be a relatively inexpensive way to hedge long portfolio positions. Similar hedges can be constructed using VIX futures.

Q: How do investors use the VIX to time the market?
A: This is a subject for a much larger space, but in general, the VIX tends to trend in the very short-term, mean-revert over the short to intermediate term, and move in cycles over a long-term time frame. The devil, of course, is in the details.

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The VIX isn’t Magical
24Jul08

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New Normal for the Oil VIX: High Levels of Fear

Much like its stock market counterpart, the Oil VIX is showing a high level of uncertainty among investors as efforts intensify for stronger regulation of energy trading.
Though well off its historic highs, the Chicago Board Options Exchange Oil VIX, or volatility index, is reflecting a strong probability of substantial price fluctuation at a time of loud public clamor over rising energy prices.
But while proponents of a stronger government hand in regulating fuel prices are using oil volatility as a factor to bolster their case, the surge in the Oil VIX may well be just another metric in the "new normal" of rapid market swings.

"It’s brutal, but it's today’s reality," said Darin Newsom, energy analyst for DTN in Omaha, Neb. "It wreaks havoc, but it places more emphasis on risk management. It places more emphasis on looking at the structure of these markets rather than following whichever winds are blowing on a particular day."

An Oil VIX above 50 sounds alarming, just as a stock market VIX above 30 sounded alarming at one point. Yet stocks have managed to sustain a powerful rally over the past three months even as the so-called "fear index" has stayed above what had long been considered a benchmark reading for high volatility.

Both measures tend to rise when the underlying value they track falls. The VIX tracks the Standard & Poor's 500, while the Oil VIX tracks the United States Oil Fund ETF (AMEX: USO).

Consequently, the Oil VIX, a relatively recent addition to the CBOE, has been on a general downward trend since last December, when crude prices reached their most recent low and started rebounding.

The unpredictability of oil prices are at the center of a lively debate on whether trading ought to be more tightly regulated in order to counter the much-maligned speculators, who have been blamed for a summertime pop in gasoline prices that seems to be unsupported by demand fundamentals.

"This is not what the commodity markets were designed to do," oil trader Daniel Dicker told CNBC. "They were never designed to be investment vehicles. They were designed to be price discovery mechanisms, and we’ve lost that trend now."

The powerful influence of speculators—primarily institutional investors and other deep-pocketed traders with the power to move markets—has long been blamed for moves such as oil's jump to $147 last summer, and gasoline's leap to $4 a gallon.

With the drumbeat for change accelerating and the mood in the new administration much more amenable to regulation, the Commodity Futures Trading Commission said Tuesday it is considering measures to clamp down on oil trading.

Some traders say a crackdown on speculation will curb the oil trade, add to the current selloff in prices and essentially amount to overkill tactics for a problem that isn’t as big as it seems.
"I don’t think there are effective ways for government to get involved and fix this," Dicker said.

Newsom added that the markets are actually behaving the way they should, generating harsh pullbacks when prices get too high such as during last year’s oil boom, and bouncing up when prices get too low, as in December’s plunge below $34 a barrel.

But should the market be going to such extremes?

"Our notions of high, low, weak, strong have changed," he said. "What used to be incredibly high volatility is not any more. It’s just natural for a market to continue to grow and evolve like that."

As for popular market measures, investors may have to widen their "normal" parameters to higher highs and lower lows, with the hope that a true price emerges in between.

An Oil VIX above 50, for instance, doesn't merely represent the threat of a move higher, but rather indicates that traders are concerned about unpredictable moves either way. At the same time, the Oil VIX has been a somewhat less reliable predictor considering it is barely a year old and lacks the history to establish reliable benchmarks.

"There's risk in both directions," said one oil trader at the CBOE who asked not to be named. "I think what it is measuring is there's a growing amount of bimodal thinking on this."

Yet the Oil VIX is about half its level from December, also indicating that traders believe the worst of the volatility has passed and that trading is more likely now to find a range.

"As a consumer in an economy that I know isn't recovering too well, it's very frustrating to watch the price of gas go up at the pump," said Andrew Wilkinson, senior strategist at Interactive Brokers. "Maybe now the fundamental forces will reassert their pressure and bring crude prices down to where [they] should be."
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Using the oil VIX to forecast energy prices
Wednesday, 13 August 2008 13:53
The VIX is a great tool for understanding investor sentiment relative to stocks. Traders were able to use the VIX to predict the most recent rally in stocks in June. If you are interested in understanding investor sentiment in other markets through a volatility index like the VIX then this article is for you. The formula used to derive the VIX's values can be applied to just about any widely traded index option and that includes oil futures options.

Oil prices have a version of the VIX called the Oil VIX (OVX) that operates the same way the stocks version does. When the oil VIX hits extremes oil prices become more prone to reversals. Unlike equities however, the oil VIX is positively correlated with oil prices because higher risk levels will increase oil prices rather than discount them. In the video, I will show you how the channel between extremes in oil market sentiment accurately predicted changes in the price trend of oil itself through 2008.

This is particularly useful now as the oil VIX is approaching another inflection point making an oil price increase more likely. This is helpful for all traders because of the intermarket affects of an increase in oil prices. Higher energy costs will be a bad thing for stocks, good for bonds, bad for the USD and great for commodity currencies. The oil VIX is one more way to manage risk and increase profit opportunities. oil
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