The VVIX, or “VIX of VIX” Index, is a measure of the expected volatility of the CBOE Volatility Index (VIX) itself.
VIX, commonly known as the “fear index,” gauges the market’s expectation of future volatility based on S&P 500 stock options.
In essence, the VVIX measures the volatility of volatility, providing investors and traders with additional insights into the market’s expectations for future fluctuations.
Let’s explore what the VVIX is, its calculation, its applications, and its limitations.
Understanding the VVIX
The VVIX is designed to reflect the market’s expectation of the 30-day forward volatility of the VIX.
It is derived from the prices of VIX options, which are options on the VIX index itself.
The VVIX provides an additional layer of information to investors by indicating how much the market expects the VIX to change over the next 30 days.
- A high VVIX value implies that the market expects significant fluctuations in the VIX.
- A low VVIX value suggests that the market expects the VIX to remain relatively stable.
By monitoring the VVIX, traders can gain insights into the market’s expectations for future volatility and adjust their portfolios accordingly.
How is the VVIX Calculated?
The VVIX calculation is based on the same methodology as the VIX, using the prices of VIX options.
The formula computes a weighted average of the implied volatilities of VIX options with different strike prices and expiration dates.
The resulting value represents the market’s expectation of the 30-day forward volatility of the VIX.
Understanding VVIX Levels
To effectively use the VVIX in trading strategies, it’s crucial to understand what various VVIX levels signify.
Generally, a VVIX level above 110 is considered high, indicating elevated expectations for future VIX volatility.
Conversely, a VVIX level below 80 is deemed low, suggesting that the market anticipates relatively stable VIX movements.
It’s essential to remember that the VVIX can be quite volatile itself and can change rapidly in response to market conditions.
Therefore, traders should use the VVIX in conjunction with other market indicators and their trading objectives to make well-informed decisions.
Applications of the VVIX
- Market Sentiment: The VVIX can provide insights into the market’s sentiment regarding future volatility. A rising VVIX may signal increased uncertainty and potential market turbulence, while a declining VVIX could indicate lower expectations for volatility and a more stable market environment.
- Hedging Strategies: Investors and traders can use the VVIX to develop hedging strategies to protect their portfolios from potential spikes in volatility. For example, investors can use VIX options or futures to hedge against a sudden increase in market volatility.
- Trading Opportunities: The VVIX can offer trading opportunities for investors who wish to speculate on changes in market volatility. By trading VIX options or futures, investors can potentially profit from changes in the VVIX.
- Diversification Tool: The VVIX can serve as an additional tool for investors seeking to diversify their portfolios. By monitoring the VVIX, investors can identify periods when the correlation between different asset classes may be heightened due to increased market volatility. This information can help them make strategic decisions to better diversify their portfolios and reduce risk.
- Market Timing: The VVIX can provide valuable information for investors looking to time their market entries and exits. For instance, a rising VVIX may suggest that it’s time to reduce risk exposure, while a falling VVIX might signal an opportunity to increase exposure to riskier assets. However, it’s essential to remember that market timing is challenging, and relying solely on the VVIX for such decisions could be risky.
Limitations of the VVIX
- Complexity: The VVIX calculation is based on a complex formula
- that may be challenging for some investors to fully grasp. This complexity can make it difficult for investors to use the VVIX effectively in their investment strategies.
- Limited History: The VVIX has a relatively short history compared to other financial indices, having been launched in 2007. This limited historical data may restrict the ability of investors to analyze long-term trends and make informed decisions based on the VVIX.
- Not Directly Investable: The VVIX is an index, and as such, it cannot be directly invested in. Investors who want to gain exposure to the VVIX must do so through VIX options or futures, which may introduce additional risks and costs
Divergence between VVIX and VIX
Divergence between the VIX (CBOE Volatility Index) and the VVIX (CBOE VVIX Index) can be significant for investors and traders because it can signal potential changes in market sentiment, risk perception, and future price movements.
Whenever VVIX diverges from VIX, it usually precedes a jump in volatility (normally this means that U.S. stocks drop sharply and USD rallies).
Remember, the VIX measures the expected volatility of the S&P 500 Index over the next 30 days based on options prices, while the VVIX measures the expected volatility of the VIX itself.
When there is a divergence between the two indices, it may indicate a shift in the market’s perception of risk or potential imbalances in the market.
Here are some reasons why a divergence between VIX and VVIX can be significant:
- Warning of increased uncertainty: If the VVIX rises while the VIX remains relatively stable or declines, it can signal that market participants are expecting increased uncertainty in the near future. This could be an early warning sign of potential market turbulence or a change in market sentiment.
- Hedging demand: A divergence between the VIX and VVIX could indicate an increased demand for hedging strategies. When the VVIX rises and the VIX remains stable, it may suggest that market participants are looking to protect their portfolios from potential spikes in volatility.
- Contrarian signal: A divergence between the VIX and VVIX can also be seen as a contrarian signal. For example, if the VIX is low but the VVIX is rising, it may suggest complacency in the market, which could be followed by a sudden increase in volatility. Conversely, if the VIX is high but the VVIX is declining, it may indicate that the market is overly concerned about the risks, and a period of lower volatility could follow.
- Market inefficiencies: Divergence between the VIX and VVIX can also highlight potential market inefficiencies. For instance, if the VVIX is rising while the VIX is declining, it could signal that the options market is pricing in a higher level of future volatility than what is currently being observed in the market. This information could be valuable for traders looking to exploit potential mispricings.
It’s important to remember that the VIX and VVIX are just two of many indicators available to investors and traders.
Divergences between the two should be considered in the context of other market factors and used in conjunction with other analysis tools to make well-informed investment decisions.
What is the VVIX/VIX ratio?
The VVIX/VIX ratio is a measure that compares the CBOE VVIX Index to the CBOE Volatility Index (VIX).
This ratio helps investors and traders assess the relative levels of volatility in the market by comparing the expected volatility of the VIX itself (VVIX) to the expected volatility of the S&P 500 Index (VIX).
To calculate the VVIX/VIX ratio, simply divide the VVIX value by the VIX value:
VVIX/VIX ratio = VVIX / VIX
This ratio can provide insights into market sentiment, risk perception, and potential shifts in the market environment.
- A higher VVIX/VIX ratio indicates that market participants are expecting a greater degree of uncertainty and fluctuations in the VIX, which in turn suggests increased volatility for the broader market.
- a lower VVIX/VIX ratio may imply that market participants anticipate a more stable VIX and lower overall market volatility.
The VVIX/VIX ratio can help identify periods of complacency or heightened risk in the market.
Comparing VVIX to Other Volatility Measures
The VVIX is just one of many volatility measures available to investors.
Some other popular volatility indicators include:
- Implied Volatility (IV): IV is derived from options prices and represents the market’s expectation of future volatility for a specific security or index. The VVIX measures the implied volatility of the VIX itself.
- Historical Volatility: Historical volatility is a measure of the actual price fluctuations of a security or index over a specific period. While the VVIX focuses on expected future volatility, historical volatility looks at past price movements.
- Average True Range (ATR): ATR is a technical analysis indicator that measures the average range between a security’s high and low prices over a specified period. Unlike the VVIX, ATR does not specifically measure volatility expectations but can provide insights into a security’s price movement dynamics.
Each volatility measure has its advantages and limitations, and investors should consider using a combination of these indicators to gain a comprehensive understanding of market volatility.
The VVIX offers investors and traders a unique perspective on the market’s expectations for future volatility by measuring the volatility of the VIX itself.
By incorporating the VVIX into their investment strategies, investors can gain valuable insights into market sentiment, identify potential hedging opportunities, and capitalize on trading opportunities arising from changes in market volatility.
However, investors must also be aware of the limitations and complexities associated with the VVIX