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What's the implied Volatility?

What is the relation between Implied Volatility of an option and VIX?

  • Will a decrease in VIX cause a corresponding reduction in premium of the option due to a decrease in implied volatility?

  • Answer:

    Basically, the VIX is an index of implied volatility of S&P 500 options with an average maturity of 30 days. VIX does the following: It is calculated from S&P 500 option prices. Options for other underliers are not used. So the VIX tracks the implied volatility for the S&P 500 index, not Apple Computers, Exxon, etc. The actual formula takes the weighted average of implied volatilities derived from the said S&P 500 options. The S&P 500 options that are chosen to be a part of the VIX index have - on average - a 30 day maturity. Under the hood, there's some interpolation done to calculate the 30 day point in the volatility curve. All available strikes for S&P 500 options are considered in the calculation. Therefore, the VIX will differ from the implied volatility of any given S&P 500 of a particular strike. The VIX is not: Directly trade-able. You can't buy or sell the VIX. You can, however, buy or sell VIX ETN and ETFs (which have imperfect tracking to the VIX). You can also trade individual single strike options to get 'exposure' to the VIX. You can also trade over the counter instruments like variance swaps. A precise indicator of 30 day volatility. As I said, the VIX is an interpolated index. Any interpolation is an estimate, so the true 30 day implied volatility may be different. A performance indicator, i.e. its chart does not tell you how much you would have 'made' or 'lost' buy going long/short volatility. The VIX index is not trade-able for this reason. The only volatility index. There's GVX (gold volatility index), RVX ( Russell 2000 volatility index),  OVX (crude oil volatility index), and so on. Always inversely correlated to S&P 500. There's a high negative correlation of -0.8, but there were times when S&P 500 and the VIX moved together for short periods of time. Btw, you would like to learn how to trade options properly & rigorously, I want to invite you to https://doggy.typeform.com/to/m9gtC4 community.Trading can suck and be really costly, especially without a good education. It’s in beta now, but it is designed to teach options trading in a proper, structured manner.

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VIX applies specifically to the volatility of the S&P500. Some stocks do follow the market very closely, and a change in VIX could have an impact on the implied volatility of these options, thought not necessarily very strong. And as it turns out, for all practical purposes, the numerical value of the VIX (not VXX, two different things) is the implied volatility of the S&P500 over the next month.

Anonymous

You need to note that as the VIX tracks the implied vol of out of the money S&P options, it does not necessarily affect the value of Dow options, Apple Options, Coke Options etc. You also need to note that the value of the option is dependent on the other Greeks, like theta and rho. Theta (time decay) plays a huge part especially in soon to expire options. Trading a demo account could help you understand options better - http://bit.ly/1FM87bI

Lin Tham

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