TSC Options Forum: Mixin' Up the VIX

Steve,

I know you've written about the VIX frequently (and think it may be overcovered), but would you mind commenting on the CBOE's new VIX formula and how some of the proposed products might be utilized? Keep up the good work.

-- D.G.

Last week, the Chicago Board of Options Exchange announced it will reformulate the calculation for its widely followed volatility index, commonly known as the VIX. More important, it has proposed to offer tradeable futures and options products based on the new VIX index. It will be released and applied on Sept. 22. The "old" VIX will continue to be tracked under its existing formula with the symbol VXO. The new products are slated for launch sometime during the fourth quarter of 2003.

New Formula, Same Taste?

The two main differences of the updated VIX are that it will be based on the S&P 500 Index (SPX) options rather than the S&P 100 Index (OEX) options, and the new formula will include a much broader range of strike prices with the at-the-monies strikes having the most weight. The old formula used just eight strikes based on 30-day at-the-money options. The goal of these two changes was to broaden the representation of overall market volatility and, therefore, its appeal and applications. A surfeit of information concerning the methodology can be found on the CBOE Web site.

Given that the S&P 500 and its options are a much more widely followed and traded benchmark than the OEX, I think the CBOE's goal will be achieved. Those who like the VIX as a contrary indicator should note that the broadening will have a dampening effect on the readings. For example, when the VIX hit a peak of 54.8% in July 2002, the "new" VIX would have only recorded a level of 45.3%. This speaks to a topic I've discussed frequently of not getting too caught up in the VIX's absolute level but rather focusing on the change in relative price and direction. In this respect, I think the VIX will still provide a reliable contrary indicator, especially for flagging oversold conditions or marking market bottoms.