Volatility has gripped the markets for much of 2016, with wild up-and-down swings roiling markets and giving way to fear (and near-panic) among investors.
If you follow the stock market, you know what the VIX is. It’s the volatility index. It’s also known as the “fear index” or “fear gauge” because increased volatility is almost always accompanied by a surge of fear.
But here’s something you may not know: the VIX is about to face some competition – and with good reason.
Yesterday, Bats Global Markets, the second largest exchange operator in the U.S., and T3 Index, an Australian developer of index products, introduced their own version of the fear gauge with the announcement of their Spikes (SPYIX) product.
Today, I want to take a closer look at what traders mean when they talk about volatility, show you exactly what the VIX is and what it does (and doesn’t do), and tell you why now is the perfect time for a new, more modern approach to how we track volatility.
Let’s get to it…
How Traders Track Volatility
The VIX is an index. It’s an indicator of expected volatility in the market. It’s actually an index of implied volatility, derived from other measures of implied volatility.
Implied volatility is important to understand, because once you understand what it is you’ll understand what the VIX really is and what the new SPYIX fear gauge really is.
Back in 1973 Fischer Black and Myron Scholes introduced the world to their options pricing equation, known as the Black-Scholes model. The model gave investors a way to calculate theoretical values of options, and launched the financial options industry.
One of the pieces of the options pricing model is a measure of volatility.
If you’re going to buy an equity option from someone, you want to know how long you’ll have the right to exercise that option and how much the underlying stock will move up or down.
