VIX at 32.80% — What Exactly Does that Mean?

Even with the problems that Greece is facing and the fact that several key technical levels were breached in U.S. market averages, many traders believe that this selloff was the result of possible technical issues, human error, and/or black-box type trades.

According to The Wall Street Journal, a report noted rumors that a major firm may have accidentally released an errant program, where a trader inadvertently placed an order to sell $16 billion (instead of $16 million) worth of e-mini S&P futures, which could have been a contributing factor of the selloff if true.

Allan Shoenberg from the CME group noted that there were also discrepancies in the relationships that some ETFs had to their underlying stocks, meaning that the mathematical rules that should exist became disconnected. Subsequently, ETFs such as the iShares Russell 1000 Value Index Fund IWD dropped from about $60.00 a share all the way to 7.5 cents, then came back to close at $59.27. This price change does not reflect the price changes of the stocks contained within.

Regardless of what exactly happened yesterday, the movements that most stocks experienced bumped the CBOE Market Volatility Index (VIX) 42% higher to the highest point it has been in almost a year.

The VIX is one of the most talked-about indexes and in my opinion, one of the least understood by the mainstream media. We must remember that the value of the VIX is the result of, not the reason for, increased volatility. VIX values are derived from a complex formula that encompasses a blend of the front two months’ of options expiring on the S&P 500 Index, across all strikes. It is, in actuality, supposed to be a rolling 30-day future value of volatility in the S&P.

Implied volatility is driven both by the observed oscillations of the underlying instrument as well as supply and demand for the options that trade on that instrument.

Volatility is generally expressed as an annualized number, so a VIX of 33% would imply that a one standard deviation move in the underlying instrument (the S&P 500) would be 33% up or 33% down over a year period, about 70% of the time. A 33% VIX also implies a daily standard deviation of about 2.1% up or down.

I thought today would be a good time to give a “quick and dirty” explanation of the VIX and what exactly it means for the markets. Whatever your opinion is of the direction of the market, when you are trading options, be sure that you are aware of both observed (historical) volatility as well as implied as they can both affect the prices of your options. We have tools on our platform to help you visualize both.

Photo Credit: epSos.de

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