In times of market turmoil, fear and uncertainty take center stage. One tool analysts use to measure this fear is the VIX, often called the “Fear Index,” published by the Chicago Board Options Exchange (CBOE).
The graph shows that the VIX value is about 20 on average but much higher during periods of extreme uncertainty, such as the onset of the COVID-19 pandemic in 2020 and the financial crisis in 2008:
- In 2020, the end-of-month peak was 53.54 in March and the daily peak was 82.69 March 16.
- In 2008, the end-of-month peak was 59.89 in October and the daily peak was 80.86 November 20.
But what exactly is the VIX?
VIX, or volatility index, is a forward-looking measure of expected future volatility in the stock market. It captures these expectations using prices of “out of the money” (OTM) put and call options on the S&P 500 index. These options are particularly useful in capturing future expectations of extreme price movements. For example, OTM put options help protect against downside risk and become more expensive when investors anticipate a decline in the S&P 500. The VIX calculates a weighted average of implied volatilities across a range of strike prices for these options, providing an estimate of expected volatility over the next 30 days.
The FRED graph shows the VIX’s countercyclical pattern over time: It rises during economic downturns and falls during booms. Why? For example, in recessions, firms borrow more and thus their stock returns could become increasingly volatile. Or investors could become more risk averse and act accordingly. Also, high uncertainty during recessions can potentially further exacerbate these economic downturns.
The VIX, as a barometer of market uncertainty, reflects the collective expectations of investors about future stock market volatility. it is clearly associated with periods of economic turmoil, but it also highlights the natural cycles of confidence and caution in financial markets.
How this graph was created: Search FRED for “VIX” and you’ll have the option to select the “CBOE Volatility Index: VIX” series, with series ID “VIXCLS.”
Suggested by Aakash Kalyani.
