Silver as an investment

An Austrian view of the VIX

sibileau.com / By Martin Sibileau / Published on January 31st 2013

A corollary of this Austrian view of the VIX is that under a system with simultaneously a gold standard (i.e. commodity backed currency) AND a 100% reserve requirement (i.e. no credit multiplier), the weight of implied correlations in the determination of a forward looking implied volatility index should be irrelevant.

Please, click here to read this article in pdf format: January 31 2013

The collapsing CBOE Volatility Index (VIX) and its implication that it is now safe to dive into equities has received much attention in the press (see here and here). Today, I want to briefly discuss what this index represents and implies

 

What is the VIX?

The VIX is a forward looking implied volatility index calculated by the Chicago Board Options Exchange (“CBOE”). The index is constructed by creating a ‘synthetic option’ based on prices paid for puts and calls on the S&P 500 on any given day. More plainly, the VIX is an attempt to measure future volatility (implied volatility) based on how much the market is willing to pay today for put and call options.

Option premiums are priced using the Black Scholes pricing formula, which ironically, was invented by the fine folks who brought you Long Term Capital Management. The formula assumes that:

a)      Price volatility follows a normal distribution (i.e. price changes are of a continuous nature and about 95% of the values lie within two standard deviations), and

b)      There is a risk free-rate of return.

Trading of options tends to focus on volatility expectations. Should market participants think volatility will be higher in the future, they will bid up the price of the index options, or the reverse, if they think volatility will be lower in the future. The VIX therefore follows the implied volatility of S&P 500 options.

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