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By: Viktor Ka

The VIX (CBOE Volatility Index) measures the market expectations of near-term volatility based on the S&P 500 stock index option prices. The VIX has been introduced in 1993, and since then it has been considered a world's premier barometer of investor sentiment and market volatility.

Until 2003 the VIX index calculation was based on the CBOE S&P 100 index (OEX). With the introduction of the new and revised, more robust calculation methodology the underlying index was changed to the CBOE S&P 500 Index options (SPX).

Another important step in the history of the VIX index was that on March 26, 2004, the VIX volatility index started to trade on the CBOE Futures Exchange (CFE).

The next step was introducing VIX options in 2006.

The VIX Futures and VIX Options were each named as most Innovative Index Products in 2004-2006 years.

The VIX volatility index is calculated in real-time by the Chicago Board of Exchange (CBOE) and is based on the weighted blend of prices of S&P 500 index options.

The VIX formula uses the current market prices for all out-of-the-money calls and puts for the front month and second month expirations with purpose to estimate the implied volatility of a synthetic, at-the-money option on the S&P 500 index, with 30 days to expiration.

It is commonly accepted by traders that that high VIX values are consistent with a greater degree of market uncertainty, while a low VIX value would point to the greater stability.

The VIX Index itself is quoted as a percentage rather than a dollar amount and there is no easy and simple way to estimate the VIX's "return". However, in this case traders uses VIX-based derivatives: VIX futures contracts (began trading in 2004), and VIX options (started to trade in February 2006).

In some cases, traders use VIX index used to analyze the overall sentiment for equity options rather than for the whole stock market. However, in many cases the relationship of the VIX to equity options can be easily overstated simply because different dynamics drive the volatility of the S&P 500 index options and individual equity options, and the two can often be uncorrelated. For instance, technology stocks are usually more volatile than the utility stocks and using VIX to represent the volatility of stock from these two sectors could be overly simplistic.

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