What is the VIX

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It measures the expected fluctuations in American stock prices and is a sentiment indicator for global markets. Now products on the Vix are causing losses and rumors. An explanation.

It has been around since 1993 - and for many years it did not attract a great deal of interest. The Vix - its full name is the CBOE Volatility Index - is calculated on the Chicago futures exchange CBOE on the basis of option prices for the stocks of American companies included in the famous S&P 500 stock index. It indicates how high the price fluctuations of American stocks expected by the buyers and sellers of these options will be in the next 30 days. The so-called volatility is a measure of fluctuations; therefore the Vix is ​​also known as a so-called volatility index. Speculative business can be done with stock options; however, they are predominantly used by large investors to hedge stock holdings against price risks.

The Vix is ​​a so-called sentiment indicator because it is widely believed that its course can be used to assess sentiment in financial markets. If market participants expect small price fluctuations, the Vix is ​​low. This is considered an indicator of serenity or carelessness. If market participants expect strong price fluctuations, the Vix is ​​high. This is considered an indicator of nervousness or, in extreme cases, panic. In financial crises, the Vix therefore increases extraordinarily strongly. Even if the basis of the Vix is ​​exclusively based on options on American stocks, it has long had a reputation as an indicator of sentiment in the global financial markets. Because the global markets are usually strongly influenced by the events on the American stock market.

The Vix has not remained an orphan. Today, many countries have such indices to measure expected price fluctuations. In 1994 the V-Dax was introduced in Germany, which measures the expected fluctuation range of the prices of the 30 German standard stocks contained in the Dax on the basis of option prices. Soon after the introduction of the Vix, large market participants in the United States expressed an interest in futures market products on the index. Both speculative and hedging transactions are possible with such products. In 2004 the Chicago futures exchange introduced futures contracts on the Vix; options followed in 2006.

Interest in financial products on the Vix has risen sharply in recent years, because in times of very low interest rates, large investors in particular have been looking for additional sources of return. With the help of providers from the financial sector and in some cases highly complex products and strategies, volatility - i.e. expected price fluctuations - was discovered as an independent asset class. A ratio of volatility as an independent asset class is based on historical studies that describe volatility as a good addition to an existing equity portfolio.

At the same time, the expected range of fluctuation on the American stock market decreased in recent years, as the mood was good and Wall Street had embarked on a stable upward trend. The Vix showed very low values ​​for a long time. In this situation, the idea of ​​developing so-called “inverse” financial products where the investor makes a profit if the Vix stays low, but loses money if the Vix goes up. These products are called “inverse” because they turn common logic on its head: Usually, an investor makes money when a price or index rises. In the case of “inverse” products, the investor loses as soon as the price or index rises.

Credit Suisse's product, the “Velocity Shares Daily Inverse Vix Short-Term ETN”, which investors rumored to have lost $ 500 million in one day, is one such product. These products were previously considered completely legitimate; the investor just has to know what he is doing. The prospectus for the product offered by Credit Suisse states that it is only intended for professionals. Since the beginning of the year, the product has suffered a price loss of 96 percent. According to the Bloomberg news agency, Credit Suisse itself was the largest investor in its product in autumn 2017, followed by Deutsche Bank, the American investment bank Morgan Stanley and the large American hedge fund Citadel. The American stock exchange regulator is now interested in the product.

The money invested in these and similar “inverse” products on the Vix is ​​valued at $ 3 to $ 6 billion in the financial industry. But that is only a fraction of the money that has been invested in the volatility asset class over the past few years. According to estimates, hedge funds alone are said to have invested around 2 trillion in this asset class.

The interactions between the Vix and the stock and other financial markets are interesting. The Vix is ​​calculated from option prices on American stocks; that is, it reflects sentiment in the American stock market. Conversely, the Vix also influences the American stock market and other financial markets. This was noticeable in the past week, when the price losses on Wall Street and many other stock markets were justified, among other things, with nervousness as a result of the unexpectedly strong rise in the Vix.

Therefore, the question arises as to whether the Vix is ​​suitable for predicting the future development of the stock markets. There have been numerous reviews of the forecasting quality of the Vix over the past few decades. The result is contradicting itself: the Vix has often been found to be useful, but it is not reliable. It would therefore be premature to declare the end of the years-long bull market on the stock market as a result of the recent sharp rise in the Vix.

The role of the Vix in global financial markets has been widely studied in recent years. The French economist Hélène Rey identified a so-called global financial cycle. It is based on the fact that unidirectional flows of capital can be observed in many regions of the world. In this way, capital flows in waves in and out of geographically distant emerging countries at the same time. It can also be stated that prices of very different investments around the world often move in the same direction. From this, Rey concludes that there is a very strong influence on the global financial markets.

In search of this influence, Rey establishes a statistical relationship between movements in international capital flows and changes in the Vix: if the Vix is ​​low in historical comparison, the volume of international capital movements increases. If the vix is ​​high, the volume of international capital movements decreases. Also, connections between the Vix and the credit growth in the world as well as connections between the Vix and debt ratios in the world can be demonstrated.

With the turbulence of the past week, a debate that has been simmering for several years about the possibility of manipulation of the Vix by market participants has also broken out openly. Attorney Jason Zuckerman, citing an anonymous insider, claims that it would be possible to manipulate the Vix by submitting completely unrealistic price bids without taking any money, as these price bids, for which no deal can be made, are included in the calculation of the Index received. The futures exchange in Chicago has rejected this allegation. Among other things, she pointed out that bids remain valid for ten minutes after they have been submitted and that the price can change significantly during this time. Since ten minutes on a futures market is a long period of time, no participant can rely on the fact that his bid, which is apparently remote from the market, will not lead to a deal after all.

In a study last year, the economists John Griffin and Amin Shams made an allegation of manipulation comparable to Zuckerman's allegations, which the futures exchange had rejected at the time. The debate about ways of manipulation is likely to continue.


The article appeared in a similar form on February 15, 2018 in the financial section of the Frankfurter Allgemeine Zeitung.

Tags: CBOE, Hélène Rey, index, options, S & P-500, V-Dax, Vix, volatility, volatility index
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The Vix - an American index with global significance

From Gerald Braunberger

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