Why should it matter to you?
Volatile indices are financial market indicators that measure the expected volatility or
fluctuations in asset prices over a specific period. There are many volatile indices each specific
for measuring the volatility for the underlying index. VIX, VXN and RVX are the ones most
prominent amongst many others.
VIX (CBOE Volatility Index) often called the “fear gauge,” measures the market’s expectation of
30-day volatility based on S&P 500 index near term options. A higher VIX indicates increased
market uncertainty or expected volatility. Similarly, VXN (CBOE NASDAQ Volatility Index)
measures the volatility for NASDAQ-100 index. It reflects the market’s expectation of volatility
for the NASDAQ-100 over the next 30 days. RVX (CBOE Russell 2000 Volatility Index) measures
the expected volatility of the Russell 2000 Index, which is a small-cap stock market index. Like
the VIX, it reflects the 30-day expected volatility but for smaller companies.
The details of the mathematical formula used to calculate the volatility of these indices is
beyond the scope of this article, Essentially, they are based on inputting real-time prices of
“Options” of the specific index, typically those with near-term expiration dates. For those who
are not from finance, ‘Options’ are the derivative contracts of any asset to either buy or sell the
underlying asset at an agreed upon price called the strike price and date called the expiration
date. Based on the inputs the formula determines the forward price of the specific index. This
forward price is used to calculate the variance and expected standard deviation of the
underlying index.
For those who would not like to delve deeper, it would be suffice to say that essentially it
measures the fear amongst various investors. Most of them are institutional and hedge funds
portfolio managers who need to balance their portfolios using ‘Options’ but there are
speculative investors as well who trade ‘Options” to earn additional profits as there are good
number of opportunities.
A week and a half ago, the release of unfavorable economic data induced the fear of recession
amongst the investors which induced higher volatility represented by VIX, VXN, RVX and many
others and this event pulled down markets. And this week, the release of favorable economic
data abated the volatility substantially and the markets appear to have recovered some ground
but not as significantly.
Unfortunately, release of economic data is not the only factor which can induce higher volatility,
it can be any global, regional or a local event capable of affecting the future course of economy,
which can affect the volatility and thus the markets behavior.
Will the markets be volatile again?
Of course they will be.
When?
Probably it will catch us all surprisingly and shockingly!!