VIX and More

Steve Sears and I have a running joke that whenever I am tapped as a guest columnist for The Striking Price at Barron’s, we should both start buying VIX calls as inevitably something is going to come along and cause a volatility spike just in time to give me something topical to discuss.

This time around I thought China might be the culprit or Greece or Puerto Rico or the Fed or maybe even the NYSE. In fact, it was a cocktail of everything that has turned a relatively quiet Q2 into a much more menacing volatility environment in Q3. In Seizing Opportunity From Stock Market Volatility, which appears today in Barron’s, I turn my attention to small caps (RUT, IWM) and use IWM vs. SPY as a way to think about relative volatility in the context of exposure to China, the euro zone and a strong dollar. Focusing on the Russell 2000 Volatility Index (RVX) and VIX, investors have been attributing roughly the same level of uncertainty and relative risk for small caps as large caps, which I see as questionable when one considers the very different exposure each asset class has to global issues and the dollar.

Given that RVX futures (VU) are thinly traded, it probably does not make sense to be short VU and long VX, the VIX futures. Another way to translate the thinking above into a strict volatility trade would be to short an at-the-money straddle for RUT or IWM, while going long an at-the-money straddle for SPX or SPY. That type of trade is probably a stretch for most Barron’s readers, but I suspect is probably right in the wheelhouse of many readers in this space. For the Barron’s article, I came up with something simpler to execute, an IWM Aug 121/123 bull put spread, which has both volatility and directional components to it and is disengaged from volatility in SPX/SPY.

In the Barron’s article, I talk a little bit about selling volatility in a post-crisis market environment or following a significant volatility event, observing:

“Selling options on the downslope of a volatility spike is often only marginally less profitable than selling options at the top of a volatility spike.”

If any of this sounds a little bit like a corollary to some of my work on “disaster imprinting” then some readers clearly have very good memories.

Related posts:

• Availability Bias and Disaster Imprinting
• VIX Data to Support Availability Bias and Disaster Imprinting Hypothesis
• The VIX:VXV Ratio, Availability Bias and Disaster Imprinting
• Be Greedy When Others Are Fearful (Barron’s)

A full list of my (16) Barron’s contributions:

• Seizing Opportunity From Stock Market Volatility (July 11, 2015)
• How to Ride an Aging Bull (November 29, 2014)
• Investors' Best Options in a ‘No Fear’ Market (July 2, 2014)
• Low Volatility: How to Profit from a Quiet VIX (May 22, 2014)
• Emerging Market Stocks: Have They Hit Bottom? (March 28, 2014)
• How to Spot Risk Early (July 16, 2013)
• How to Insure Your Stock Portfolio (April 18, 2013)
• The Case for Options Trading (January 2, 2013)
• Calm Down and Exploit Others’ Anxieties (November 14, 2012)
• How to Trade Options Around Volatile Events (July 10, 2012)
• Be Greedy While Others Are Fearful (May 3, 2012)
• Ways to Turn Volatility into an Asset Class (January 12, 2011)
• There’s Opportunity in Uncertainty (November 18, 2010)
• Will Market Volatility Return to Crisis Levels? (September 15, 2010)
• The Perils of Predicting Volatility (May 20, 2010)
• Take a Longer View on Volatility (July 2, 2009)

Disclosure(s): none

‘Tis the season for the annual holiday effect in which historical volatility (HV) has a strong tendency to plunge and drag implied volatility down with it. This is a subject I have tackled on a number of occasions in the past (see links below) and is really just a longer variant of what I call calendar reversion – the tendency of the VIX to fall an extra 1% or so on Fridays due to market makers adjusting prices ahead of the weekend. The lack of volatility all boils down to the same root cause: fewer trading days during the 30 calendar day window specified by the VIX (and implied volatility in general) means there are fewer opportunity for stocks to stray significantly from the path projected by efficient markets, standard deviations and the rest of the normalcy regime.

As of Friday’s close the S&P 500 index had a 10-day historical volatility of 5.5, which is the lowest reading since May 2007. In this week’s chart of the week below, I have elected to show the 10-day historical volatility of the Russell 2000 small cap index (RUT), which traditionally has higher volatility than the SPX and is also more susceptible to the winds of economic change and uncertainty. As the chart shows, 10-day historical volatility (white line) sits at a two-year low and has helped to pull the implied volatility (red line) of the index down below 20. Note that last week the CBOE Russell 2000 Volatility Index (RVX) dipped as low as 19.55 and is threatening to drop below the 19.00 level for the first time since June 2007.

After the first of the year I expect to see the holiday effect magically disappear and HV, IV and volatility indices begin to reflect a more accurate view of investor expectations.

Related posts:

• SPX Historical Volatility at Two Year Low
• Historical Volatility and Seasonality Push VIX Below 20
• Historical Volatility Pointing to a Sub-20 VIX
• VIX Holiday Crush
• Sideways Markets, Covered Calls and the RUT
  

Since I have not seen this mentioned elsewhere, I thought I should point out that there was an interesting and very unusual divergence in the major U.S. volatility indices today. As the chart below shows, both VXO and RVX posted substantial gains, up 5.7% and 4.5% respectively. The other three major volatility indices declined, with VXN down 1.9%, VIX down 2.2% and VXD down 3.6%.

With no obvious gaps in any of the charts nor a single index outlier, there are no obvious signs of bad data at work. While correlations among these five indices run in the 97% - 99% range and divergences are largely accounted for by different market capitalizations, the fact that the two gainers were the large cap VXO and the small cap RVX makes today's numbers particularly difficult to explain.

Frankly, I am a loss for a good way to account for the discrepancy. The drop in the VIX futures and VIX ETNs (VXX and VXZ) suggests to me that perhaps VXO and RVX were hit with a similar technical glitch, but I have not seen any public statement to support this.

Anyone care to venture an explanation?

For more on related subjects, readers are encouraged to check out:

• Overview of the U.S. Volatility Indices
• The Evolution of the Volatility Index Family Tree
• Comparative Volatility Indices
• Meet the Spikers
• Is the VIX Being Gamed?
• SPX Options Carpet Bomb Pushes VIX SOQ to 63.04 (!)

Disclosure(s): neutral position via options in VIX at time of writing

I had originally thought that I might begin 2010 with a series of articles on covered calls and other ways of using options to generate additional returns during sideways market action. Since several other writers have already jumped on this subject (notably Jeff Opdyke of the Wall Street Journal in Covered Calls Prove Popular Strategy; Mark Wolfinger of Options for Rookies in Writing Covered Calls in 2010; and Adam Warner of Options Zone in When Is the Best Time to Use a Buy-Write?) I am going to start slowly with these pointers above and a handful of links to previous posts below.

There is another point I wish to make. As of today’s close, the RVX, which is the volatility index for the Russell 2000 small cap index (RUT), is 33.8% higher than the VIX. As the chart below shows, this is at the high end of the range for the past year. Should volatility return to the markets, then I can certainly see how one might anticipate higher volatility in small caps than in the SPX. On the other hand, if stocks are going to continue to move sideways as they did today, then sellers of RUT options (straddles, strangles, iron condors, butterflies, etc.) should receive extra compensation for their short volatility positions.

For more on related subjects, readers are encouraged to check out:

• The Value of Selling Covered Calls
• The Often Overlooked Put Writing Strategy
• Unusual Chart of the Month: VXO and RVX
• One Approach for Volatile Sideways Markets
• BuyWrite Index as a Timing Tool?

[source: StockCharts]

Disclosure: none

In Fear Index Now Inverse to VIX, Zero Hedge recently put forth the idea that the VIX is “being gamed by volatility sellers” and may be “the most behind the scenes manipulated index.”

Several readers have asked me to comment on this. In short, I do not believe the VIX is being gamed to any significant extent. Among the volatility data I watch are the correlations across the various major volatility indices, including the VIX, VXN (for the NASDAQ-100), RVX (for the Russell 2000), VXO (for the S&P 100 index) and VXD (for the Dow Jones Industrial Average.) Historically, the lowest of these correlations has been the two market cap extremes, a 97% correlation between the RVX and the VXO. Frankly, I have not seen much of a deviation from historical patterns over the course of the past few weeks. The charts below show all five volatility indices over the course of the past one month (top) and three months (bottom). If there is any evidence to support the VIX as deviating from the other volatility indices, I don’t see it.

Note that because the VXO does not have any options or futures associated with it, gaming that volatility index would likely be the most difficult and expensive of the group. Also consider that because the components of the VXO have the largest market caps of any of the volatility indices, one would expect changes in the VXO to be less dramatic than those of the other indices that are populated by smaller and more volatile companies.

For related posts on the other secondary volatility indices, try:

• Overview of U.S. Volatility Indices
  
• The Evolution of the Volatility Index Family Tree
  
• Comparative Volatility Indices
  
  

[source: BigCharts]

Disclosure: Long VIX at time of writing.

Being a West Coast guy, I often find myself three hours behind the rest of the blogging world when I stumble out of bed. Once or twice a year, I manage to sleep through the open and generally spend the rest of the day playing catch-up, as has been the case today. Now that I am mostly coherent and have digested the bulk of the news and market movements for the first three hours of today’s session, let me offer some comments.

While stocks are enjoying an Intel (INTC) inside jump, the VIX is up a shade as I type this, seemingly intent on staying above the 25.00 level. On the other hand, three of other major market index volatility measures I follow (VXN, RVX and VXD) are all down in the 5-7% range for the day. The outlier among the secondary volatility indices is VXO, the volatility index for the S&P 100 index (OEX), which is only down about 2% on the day. (I am not sure exactly how to parse this information, but with the meat of second quarter earnings season just around the corner and options expiration only two days away, I would not be surprised to learn that portfolio managers are looking to lock in some profits and add some additional downside protection.)

In the last day or two, a number of other bloggers have commented up on the volatility premium issue. In VIX Predicting the Future…and It’s Cloudy, Jason Goepfert of Sentiment’s Edge has an excellent chart of the premium of the front-month VIX futures to the spot VIX index and points out that a high premium has lately been bearish for stocks. Adam Warner of Daily Options Report picks up the premium theme in While We Were Churning…… as does the Decline and Fall of Western Civilization blog in Volatility Curve Warning Again.

The premise is exactly the same reasoning as is behind the VIX:VXV ratio and the VXX:VXZ ratio: when short-term volatility measures become substantially out of line with longer-term volatility measures, the divergence is most likely to be resolved by the short-term measure ‘correcting’ in the direction of the longer-term measure. With the VIX:VXV ratio recently hovering around 0.85, this means a VIX spike is more likely to take the ratio back toward equilibrium than a substantial drop in the VXV index. By the same token, VXX and VXZ are more likely to converge as a result of a jump in VXX than a decline in VXZ. Of course, the numerator and denominator can always converge at the same rate, but that type of resolution seems to be relatively rare.

For those who may be interested, my various estimates of fair value for the VIX are largely in the range of about 28-29 at the moment, suggesting that short-term volatility is due for a bounce soon.

As a reminder, anyone wishing to speculate on the VIX using options and futures should note that VIX options expire next Wednesday (July 22), with the last day of trading on Tuesday.

Today’s dramatic last hour selloff resulted in new record high closes in four of the seven major U.S. volatility indices, including the VIX, which exceeded 60 for the first time and established a new record close of 63.92. In addition to the VIX, the VXD (CBOE DJIA Volatility Index) and the RVX (CBOE Russell 2000 Volatility Index) also set new records.

Note that these volatility indices have different life spans and data histories, so the comparisons of all-time record highs across indices are not always particularly relevant. For more information on all of the volatility indices, try Overview of U.S. Volatility Indices.

Based on the large number of Google searches that have recently been landing on the blog, there is considerable interest in the CBOE’s new “Oil VIX” or crude oil volatility index (ticker OVX), which was launched exactly four weeks ago today.

While it is still too early to pluck much in the way of useful conclusions from the OVX, I have included a chart of the new volatility index below. So far what may surprise most newcomers to crude oil volatility is that the OVX has fallen in concert with crude oil prices (as measured by the USO crude oil ETF). My analysis of USO options suggests that crude oil implied volatility and the price of the underlying are likely to be largely uncorrelated going forward, which is in sharp contrast to the strong negative correlation between equities and their corresponding volatility indices, such as the VIX, the VXN, and the RVX.

In the past, I have been accused of dreaming up strange and unusual charts just for the fun of it. I will gladly enter a guilty plea on that one. In fact, I enjoy cajoling the Department of Strange and Unusual Charts to come up with something that readers have never encountered before.

If the chart below looks a little out of the ordinary, chalk it up to that personality disorder I have already confessed to. Before trying to interpret whether the chart has any possible validity, it is important to take a step back. Consider that each chart contains at least one hypothesis about a relationship between various data points and/or data sets. At first glance that hypothesis might seem outrageous or merely coincidental. The point of the strange and unusual charts is that it is more important to drag those hypotheses out into the open and give readers an opportunity to pause and reflect on them than it is to present each hypothesis as unassailable .

In the long run, it is those strange and unusual relationships that no one else sees, but which persist over time, that provide a meaningful trading edge. So keep an open mind and keep looking.

Turning to the ratio of the VXO to the RVX, recall that the VXO is the ‘original VIX’ and reflects the volatility associated with the large cap S&P 100 index (OEX). The RVX, on the other hand, is the volatility index for the Russell 2000 small cap index (RUT). Small caps have been outperforming large caps lately, so it is not surprising to see recent volatility trending higher with the large caps. What did surprise me, however, was to see that a spike in the VXO relative to the RVX has been an excellent indicator of market bottoms over the past two years. If we extrapolate from the past, the current levels of the VXO versus the RVX also suggest a likely intermediate market bottom, at least in the SPX, which is represented by a gray area chart in the graph. Unassailable? No. Worth watching going forward? Absolutely.

I am a strong believer in simplifying life – and one’s approach to investing – as much as possible. Less is more.

With that thought in mind, I pulled up a six month chart of the five major US volatility indices: VIX, VXO, VXN, RVX, and VXD. The chart, which comes courtesy of BigCharts, shows that over the past six months, the difference between the volatility indices are no more than subtle nuances. Keep in mind that during this period, the financial sector was extremely hard hit. Moreover, financials are overrepresented in the VIX and VXO, underrepresented in the RVX, and absent from the VXN. The sector distinction is all but lost in the charts (except perhaps from mid-February to mid-March) and if there were ever a time for the indices to diverge in a meaningful way, this was it.

The bottom line is that for most market observers, it makes sense to follow only the VIX. Volatility aficionados may also choose to follow the VXN, but after adding a second volatility index to one’s radar, the incremental return on effort and complexity diminishes rapidly.

When there are important divergences between these indices, I will be quick to point these out, but for the most part, expect my comments about the VIX to apply to the entire volatility index family tree as a whole.

I have had quite a few requests to present some introductory material on the VIX, so with that in mind I offer up the following in question and answer format:

Q: What is the VIX?
A: In brief, the VIX is the ticker symbol for the volatility index that the Chicago Board Options Exchange (CBOE) created to calculate the implied volatility of options on the S&P 500 index (SPX) for the next 30 calendar days. The formal name of the VIX is the CBOE Volatility Index.

Q: How is the VIX calculated?
A: The CBOE utilizes a wide variety of strike prices for SPX puts and calls to calculate the VIX. In order to arrive at a 30 day implied volatility value, the calculation blends options expiring on two different dates, with the result being an interpolated implied volatility number. For the record, the CBOE does not use the Black-Scholes option pricing model. Details of the VIX calculations are available from the CBOE in their VIX white paper.

Q: Why should I care about the VIX?
A: There are several reasons to pay attention to the VIX. Most investors who monitor the VIX do so because it provides important information about investor sentiment that can be helpful in evaluating potential market turning points. A smaller group of investors use VIX options and VIX futures to hedge their portfolios; other investors use those same options and futures as well as VIX exchange traded notes (primarily VXX) to speculate on the future direction of the market.

Q: What is the history of the VIX?
A: The VIX was originally launched in 1993, with a slightly different calculation than the one that is currently employed. The ‘original VIX’ (which is still tracked under the ticker VXO) differs from the current VIX in two main respects: it is based on the S&P 100 (OEX) instead of the S&P 500; and it targets at the money options instead of the broad range of strikes utilized by the VIX. The current VIX was reformulated on September 22, 2003, at which time the original VIX was assigned the VXO ticker. VIX futures began trading on March 26, 2004; VIX options followed on February 24, 2006; and two VIX exchange traded notes (VXX and VXZ) were added to the mix on January 30, 2009.

Q: Why is the VIX sometimes called the “fear index”?
A: The CBOE has actively encouraged the use of the VIX as a tool for measuring investor fear in their marketing of the VIX and VIX-related products. As the CBOE puts it, “since volatility often signifies financial turmoil, [the] VIX is often referred to as the ‘investor fear gauge’”. The media has been quick to latch onto the headline value of the VIX as a fear indicator and has helped to reinforce the relationship between the VIX and investor fear.

Q: How does the VIX differ from other measures of volatility?
A: The VIX is the most widely known of a number of volatility indices. The CBOE alone recognizes nine volatility indices, the most popular of which are the VIX, the VXO, the VXN (for the NASDAQ-100 index), and the RVX (for the Russell 2000 small cap index). In addition to volatility indices for US equities, there are volatility indices for foreign equities (VDAX, VSTOXX, VSMI, VX1, MVX, VAEX, VBEL, VCAC, etc.) as well as lesser known volatility indices for other asset classes such as oil, gold and currencies.

Q: What are normal, high and low readings for the VIX?
A: This question is more complicated than it sounds, because some people focus on absolute VIX numbers and some people focus on relative VIX numbers. On an absolute basis, looking at a VIX as reformulated in 2003, but using data reverse engineered going back to 1990, the mean is a little bit over 20, the high is just below 90 and the low is just below 10. Just for fun, using the VXO (original VIX formulation), it is possible to calculate that the VXO peaked at about 172 on Black Monday, October 19, 1987.

Q: Can I trade the VIX?
A: At this time it is not possible to trade the cash or spot VIX directly. The only way to take a position on the VIX is through the use of VIX options and futures or on two VIX ETNs that are based on VIX futures: VXX, which targets VIX futures with 1 month to maturity; and VXZ, which targets 5 months to maturity. An inverse VIX futures ETN, XXV, was launched on 7/19/10. This product targets VIX futures with 1 month to maturity. As of May 2010, options have been available on the VXX and VXZ ETNs.

Q: How can the VIX be used as a hedge?
A: The VIX is appropriate as a hedging tool because it has a strong negative correlation to the SPX – and is generally about four times more volatile. For this reason, portfolio managers often find that buying of out of the money calls on the VIX to be a relatively inexpensive way to hedge long portfolio positions. Similar hedges can be constructed using VIX futures or the VIX ETNs.

Q: How do investors use the VIX to time the market?
A: This is a subject for a much larger space, but in general, the VIX tends to trend in the very short-term, mean-revert over the short to intermediate term, and move in cycles over a long-term time frame. The devil, of course, is in the details.

Just a quick note to remind anyone who is trading VIX options that the February options expirations calendar [which is pinned at the bottom of the "VIX & Sentiment Links" in the upper right hand corner of the blog] has some unusual features that are the result of the timing of Good Friday, which falls on expiration week in March this year.

Without getting into all the details, the bottom line is that the expiration day for February's VIX options is Tuesday, February 19^th, instead of the usual Wednesday. With the President’s Day holiday falling on Monday the 18^th, this moves the last trading day in VIX options up to Friday, February 15^th – the day after tomorrow. Note that the same expiration and last trading dates also apply to VXN and RVX options.

Anyone who wishes to dive into the details of the VIX options calendar and other related information is encouraged to brush up on the VIX options contract specifications.

The attached chart shows the VXN (volatility index for the NASDAQ-100 or NDX) over the past five years, with a 10 day simple moving average, flanked by dotted lines representing 20% above and below the 10 day SMA.

Anybody who has been paying attention knows that the last several days have been highly unusual. As the chart shows, the VXN, which rarely closes outside of those 20% bands, is currently 38.2% above the 10 day SMA. This is about as extreme as it gets for volatility outliers and suggests a high probability of a sharp reversion to the mean in the VXN, coincident with a bounce back in the NDX.

For the record, the same market bottom signal is coming from the VIX and SPX, but without the extreme reading that is characterized by the VXN and NDX. By contrast, the signal from the RXV and RUT is substantially weaker and only marginally tradeable.

Volatility signals with this level of confidence are extremely rare, so if you are looking for an excuse to get long in a big way for the short term, or to trade VIX along the lines recently suggested by Brian Overby, today is an excellent opportunity to try to time the markets.

When I started this blog, one of the reasons I decided to call it “VIX and More” was that unlike other options indices, it was possible to trade VIX options. Well…I won’t be renaming the blog, but as of yesterday, the CBOE is now trading options on the VXN (NASDAQ-100 Volatility Index) and RVX (Russell 2000 Volatility Index.)

I reported on this development when it was first announced and recently offered up some graphs on comparative performance of the major US volatility indices, but clearly it is time to update the full volatility options tree.

With the new VXN and RVX options, the US volatility indices now stack up as follows:

Additionally, the CBOE has added a new splash page for all five of the volatility indices, which I have pinned to the upper right hand corner of the blog.

The CBOE has also used the occasion of the launch of options on the VXN and RVX to provide some data on these indices that may be of interest to readers. I found it particularly interesting that in terms of activity in the futures (launched July 6, 2007), investors have so far favored the RVX to the VXN by a large margin:

Perhaps related to the above, while a graphic published by the CBOE shows that the VIX has a stronger (negative) correlation to the SPX than do the other volatility indices to their counterparts, it also seems that the relationship between the RVX and the RUT is stronger than that of the VXN and the NDX:

Finally, those interested in implied volatility for the new options can click on the RVX and VXN links to get the appropriate information and graphs from iVolatility.com. From a historical volatility perspective, these two indices look fairly similar at the moment, but I will keep a close eye on them going forward and report any noteworthy divergences.

I last put up a chart of the five US equity volatility indices in mid-March, following the February 27th VIX spike. Now that we also have about three weeks following the VIX spike, I thought I might put up a similar chart of the volatility indices for the recent market action.

The recent volatility spike (top chart) shows VXO once again leading the charge upward, with VXN the laggard -- just as was the case in March. Interestingly, during the secondary surge in volatility over the past two weeks or so, the VXN has been the most sensitive.

With VXN and RVX options just around the corner, the relative movements of these volatility indices are becoming increasingly more interesting (and important) to watch.

The CBOE announced yesterday that it plans to begin trading options on the VXN (NASDAQ-100 Volatility Index) and the RVX (Russell 2000 Volatility Index) as of September 27, 2007.

This announcement comes just two months after the CBOE began trading futures in the VXN and RVX.

While VIX and More will not quite provide tick by tick coverage of VXN and RVX options, it is a fairly safe bet that I will have more to say about them than just about anyone else.

On the off chance that there are readers out there who have not bothered to read Bernie Schaeffer’s market commentary because it requires a free registration to Schaeffer’s Research, you really should rethink that idea. Take, for instance, Schaffer’s “Monday Morning Outlook: Fear Swells Amid Market Pullback,” which was published earlier this morning. Here Schaeffer pulls a gem from Stonebrook Structured Products, a provider of hedge fund replication strategies:

“A large part of hedge fund returns are driven by shorting large-cap growth and the going long small-cap value and emerging market equity. True alpha accounts for only 20-25% of industry returns.”

Schaeffer extends this idea to come up with a hypothesis for the recent substantial performance gap for small caps (as evidenced by the Russell 2000 falling almost three times as hard as the large cap indices):

“Once the more volatile smaller-cap stocks began to seriously under perform the S&P, their short S&P hedges were not sufficiently protecting them (which caused them to be ‘too long’ in a market correction) and the hedge funds then needed to go out and sell stock from their portfolios and/or short the IWM or buy IWM puts. And all of this served to further blast the IWM.”

Interestingly, a look at the volatility of the Russell 2000 index (RVX) compared to the VIX does not reveal the underlying dynamic that Schaeffer suggested, but a study of the ratio of the IWM to the SPY does support his contention. See the two charts below for a better sense of this.

One key takeaway from this exercise is that some important volatility-related information is flying under the radar of the volatility indices. Another key takeaway is that ETFs are not only the driving the force in the markets these days, but they need to be a central part of any market technician’s analytical toolbox as well.

From the in-case-you-missed-it department, comes a June 11 announcement by the CBOE that the CBOE Futures Exchange (CFE) has launched "two new volatility index futures contracts on the CBOE Nasdaq-100 Volatility Index (ticker symbol VXN, futures symbol VN) and the CBOE Russell 2000 Volatility Index (ticker symbol RVX, futures symbol VR) beginning July 6, 2007."

More information is available from the CBOE for the VXN futures and RVX futures in the links to the left.

Among other things, this means I will now be paying much closer attention to the VXN and the RVX.

Quadruple witching day seems like as good a day as any to meet the family. Having already introduced VDAX, the VIX’s German cousin, today we look at the US relatives. First, the handy chart:

Due to marriages, divorces, name changes and the like, a more detailed look at the US extended family can get complicated, but here are the five key players, roughly in order of their current significance in the markets:

VIX – measures implied volatility for S&P 500 (SPX) options for all near term at-the-money SPX puts and calls and out-of-the-money puts and calls. Deep-in-the-money options are excluded. The current methodology has been in use since 9/22/03. The VIX was officially introduced on 4/1/93, but the CBOE has calculated synthetic historical VIX data going back to the beginning of 1990.

VXN – measures implied volatility for the Nasdaq 100 (NDX) options for all near term at-the-money NDX puts and calls and out-of-the-money puts and calls. Deep-in-the-money options are excluded. The current methodology has been in use since 9/22/03; the index was originally introduced on 1/22/01.

VXO – is calculated by taking the weighted average of the implied volatility of 8 S&P 100 OEX calls and puts with an average time to expiration of 30 days. Note that this is the methodology that was used to calculate the VIX prior to 9/22/03. On that date, the method used to calculate the VIX was changed and a new ticker symbol and name was introduced to provide continuity with the historical method of calculating the "old VIX" prior to 9/22/03.

From the CBOE site:

"VIX measures market expectation of near term volatility conveyed by stock index option prices. The original VIX was constructed using the implied volatilities of eight different OEX option series so that, at any given time, it represented the implied volatility of a hypothetical at-the-money OEX option with exactly 30 days to expiration.

The New VIX still measures the market's expectation of 30-day volatility, but in a way that conforms to the latest thinking and research among industry practitioners. The New VIX is based on S&P 500 index option prices and incorporates information from the volatility ‘skew’ by using a wider range of strike prices rather than just at-the-money series."

VXD – measures implied volatility for the Dow Jones Industrial Average options for all near term at-the-money DJIA puts and calls and out-of-the-money puts and calls. Deep-in-the-money options are excluded. Introduced on 4/25/05.

RVX – measures implied volatility for the Russell 2000 (RUT) options for all near term at-the-money NDX puts and calls and out-of-the-money puts and calls. Deep-in-the-money options are excluded. Introduced on 5/5/06.

While there is a very high degree of correlation among the volatility indices, like any family, this family does not always move in lockstep fashion, as the graph below demonstrates. In the coming weeks, I will talk more about divergence among the volatility indices and attempt to provide a framework for interpreting them.