Archive for November 14, 2007

Volatility & VIX

November 14, 2007 @ 10:51 pm · Filed under Economics, Finance

I was having a conversation earlier in the day with BPSK on one of the articles from today’s WSJ that talked about correlations between the Japanese Yen and investor confidence. It’s a rather interesting article, and the topic of VIX came up.

For those that do not know what VIX is, it stands for Volatility IndeX and is a measure of the volatility of the S&P 500 options.

I was trying to recount the disadvantages of using a single index but could not go beyond the criticisms that Wikipedia raked up, namely –

  • It depicts the overall volatility for options and not for any one. Therefore, how much it may apply to specific options is debatable.
  • The fact that the VIX only applies to a 30-day period could mean that it could be temporarily exploited by futures traders to artificially drive up the volatility.
  • The applicability and correlations between what drives volatility of index options to what drives equities options is questionable.
  • The amount of liquidity available in the market for specific types of options varies based on the specific option in question; an overall index is too simplistic.

Of course, there are probably other reasons why the VIX works or does not work. And I most certainly do not know enough about the options industry to comment upon it, except cursory knowledge.

So, do any of you finance gurus out there have any further thoughts on this topic?

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