Understanding the Four Measures of Volatility

Type 3: Volatility Indices

Just as we can calculate a stock's volatility or the implied volatility from its options, we can do so for an index such as the S&P 500(SPX Quote) or its exchange-traded fund equivalent, the Spyders (SPY Quote). This concept is taken one step further. For many indices, a volatility index has been created and is commonly quoted in the financial media. The three most common ones:

• S&P 500 Volatility Index (VIX Quote)
• S&P 100 Volatility Index (VXO Quote)
• Nasdaq 100 Volatility Index (VXN Quote)

These volatility indices are a weighted average of the implied volatilities for several series of options (puts and calls). Many market participants and observers will use these indices as a gauge of market sentiment. The CBOE Web site has some interesting information on the VIX, other volatility indices and related products.

Presented below are the volatility indices for March 6, 2007 and the week prior to that date after the market took its big one-day plunge. Note the huge surge in volatility in response to the market drop.

Also, observe the relationship between the individual stocks' implied volatilities and that of the indices. JNJ options are slightly less volatile than the S&P 500 Volatility Index and the S&P 100 Volatility Index for which it is a constituent. RACK options, on the other hand, are significantly more volatile in implied measures than options for the tech-heavy Nasdaq 100 Volatility Index.

Click here to view the volatility indices chart.