How to Calculate Volatility

How to Calculate Volatility
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The Volatility Index (abbreviated as VIX) is a formula that has been designed in 1993 by the Chicago Board Options Exchange (CBOE) to measure the 30-day volatility of market prices. Originally, the measure relied on the S&P 100 Index (OEX) and estimated the expected volatility in the markets by calculating the at-the-money prices of the OEX. In 2003, however, the CBOE in cooperation with Goldman Sachs updated the VIX according to the S&P 500 Index (SPX), the primary index for U.S. equities. The new way of measuring volatility gauges the shifts of the market through the averages of weighted prices of puts and calls in the relation to the SPX over a wide range of prices. Soon after its introduction, the VIX gained prominence as the benchmark stock market volatility index, and the new VIX has provided investors with a practical way of applying volatility forecasts to their trades. By means of its new methodology, the VIX currently produces volatility estimates for many indices, from broad ones like the Dow Jones Industrial Average (DJX) to more narrow asset-specific ones like the Gold Volatility Index (GVZ) and the Euro Currency Volatility Index (EVZ).

How the Volatility Index Works

The Volatility Index comprises put and call options either in the current month or the next month (if the current-month expiry date falls within less than a week), which are called near- and next-term options respectively. The VIX measurement is given as a number between 0 and 100, with the lower numbers on the scale forecasting greater stability in the markets and higher ones indicating greater volatility. This figure represents the degree of anticipated market movement (both up and down) in terms of percentages.

Applying Volatility Numbers to Your Trade

One of the choices offered to you on the Banc De Binary options trading platform is that of trading indices. The first step to gauging the health of the index that interests you relative to the market is to follow market news and events about the stocks included in the index. But this type of analysis alone may not provide you with sufficient clues to the index’s future performance, and taking into consideration the VIX formula can significantly support and supplement your estimates. If, for example, an index you are interested in receives a VIX estimation of 36, you should consider the index quite stable for the next month. To be more precise, the number suggests that options traders anticipate a movement in the market within the range of 3 percent (36 divided by 12). Although the number is not by any means prescriptive of the market’s movements, it provides an accurate insight to investors’ attitudes and sentiment towards market conditions.

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