What is the VIX | Understanding Market Volatility - YouTube

Hi there! My name is Scott Bauer,  CEO of Prosper Trading Academy.  

And today we're going to talk  about the VIX: what is the VIX,  

how does it relate to the market and  volatility, and what it really means.  

Knowing these things is very important for you  as an option trader. So let's get right into it. 

What does the VIX really tell us, what does  it really measure? We hear about it on TV  

all the time: it's the fear index, measures  volatility. Great, but what does it really  

measure? One thing to keep in mind when  talking about volatility in the marketplace,  

is that volatility is a measurement for movement.  In life, when people start to get fearful,  

nervous, what happens? Volatility goes up.  Right? Your antennas start to to go off.  

So you're always looking for protection, you're,  you know, god forbid something happens, or just  

something out of the ordinary even. We all, it's  human nature, we all get nervous. So VIX really  

measures the same thing but for the market. We  typically see the VIX increase when the market is  

dropping. And pull that back to just human nature:  when the market's dropping, for the most part,  

the majority of people don't want the market to  drop, you get fearful. The VIX in volatility goes  

up when there is nervousness, uncertainty, right,  uncertainty is really the driver of volatility  

in - anything. In any instance. When the VIX  was brought to market, the VIX was a measure of  

market volatility, but what does that really mean?  Right. What do the numbers to that really mean? So  

let's go through some of this here. Okay so, what  the VIX is - it's a measurement that represents

the market expectations for  a move in the S&Ps, the SPX,  

in the next 30 days. Okay, it is a forward-looking  indicator, 30-day forward-looking indicator of  

volatility. The VIX is really only measuring  S&P activity. So it's used, or it's calculated  

by using SPX options which are the S&P 500 options  at the CBOE that are 30 days out. And what it's  

doing is, it's taking not just the at the money  prices, but the calculation. The model takes  

a wide range of strikes. What it does, it  weights prices of puts and calls over a range -

of strike prices in the SPX. So it's not  just taking the at the money volatility  

though. That is the pretty much the the biggest  indicator. So great. It aggregates all of this  

data but what does it mean, and how can we  use it other than knowing again looking at a  

chart here and saying wow over the last you  know 12 ,18 months we've seen lower lows,  

lower highs. But what is normal? What  I have on the screen up here now,  

this is a two-year chart of VIX. So we can see  prior to covid where the VIX really settled in.  

Okay, and that was in the low to  mid teens for the longest time.  

The VIX traded in the low to mid teens and  then obviously saw this massive spike up here  

when the world fell apart. And as we have been  getting back to you know some sense of normalcy,  

we've been seeing the VIX trend back to that  area of, you know, normalcy. Okay, but here's  

what the VIX really measures. Okay, again, it  represents an expected range, an expected move,  

just like how we calculate our expected  moves in every setup that we go through,  

right. To try and determine which strikes  to use the VIX does the same thing it also -

is represented by a 68% confidence level. Which is  mathematically the same thing that that we always  

calculate. One standard deviation. Okay, what  does that mean? Well for those of you that ever  

remember taking a, maybe, an exam in college ,or  your kids did when the professor would say, you  

know, we're gonna curve your grade. Okay, the old  bell curve, what that meant was all of the data -

that is inside the curve here  the bell that represents 68% -

of all of the outcomes. That's statistically,  mathematically, one standard deviation.  

Okay, that's what the option pricing model that  everybody uses the, black shoals pricing model,  

prices in is options with a 68 probability in the  move. So let's say the VIX is $20, where it is  

right now. Okay what does this actually mean?  What is this representing? To us, in terms of  

how much the market, when I say the market I'm  referring to the S&Ps are likely to move. Well  

remember, the VIX itself is a one month, a 30-day  forward-looking measurement. So you would think  

that that is just divided by 12, right? Because  there's 12 months in the year. If we wanted to  

figure out a monthly move you would think that  the VIX would be - if it's 20 that means it's a 20  

expected move in a month. But that's not the case.  

So the expected vol. range for a month is  calculated by taking the VIX divided by  

not 12, or monthly, but the square root of 12.  That is the math behind how the VIX is calculated.  

So, if we were to do this calculation  and take 20 where the VIX is right now,  

divided by the square root of 12, when the  square root of 12 is roughly 3.5. Okay, I'm  

just gonna round it off. So if we take 20 divided  by 3.5. Get out my calculator here - we get 5.7.  

That means a VIX of 20 is actually representing  that the market is pricing in a move of 5.7%  

over the next 30 days. Again, this doesn't tell  us direction just like when we figure out the  

expected move when we're looking at a stock,  it doesn't tell us direction, it just guides us  

to the size of the move. So if we were to compare  that to a VIX that is closer to its historic  

levels, okay, if we were to use the  same calculation but use the VIX at 15 -

okay, we would take 15 divided by that same -

denominator of roughly 3.5.  Remember, square root of 12.  

And if we do that that calculation - comes out to  4.29%. 4.3%, I'll round it off. So, if the VIX was  

15 instead of 20, then the expected move over  the next month is 4.3. And if the VIX was 30 -

instead of 20, then we  would take 30 divided by 3.5  

and now what that is representing is a move an  expected move of 8.6% over the next month. So,  

if those are the expected moves based on where  the VIX is, then the options need to be adjusted  

appropriately to represent those moves. Now  let's do that for a week rather than a month.  

Let's break it down to a week. Well if you use  the same logic when we were doing it for a month  

12 months in a year we took the square  root of 12, right. If we do it for a week -

we use the square root of 52 as our denominator.  So the square root of 52 is roughly 7.2. Okay,  

so a VIX of 20 divided by 7.2, okay, if we were  looking for a weekly move that equals about 2.8%.  

So on and so forth. And we can obviously do  the calculations for if the VIX was 15, 30,  

50, whatever it is. And if we were looking  for the daily move, which I personally think  

is the most important measurement to look at.  We take the square root of 365 and we use 365  

because even though there are only about  250-ish actual trading days in the year. 255  

so you know something like that - options don't  stop working because of an off day in the market;  

options still decay on a daily basis even on  weekends, even on holidays. So we use the square  

root of 365, which is roughly 19. So a VIX of 20  divided by 19, okay. Gives us 1.05%. So if the  

VIX is trading 20, that is representative of the  market moving one percent a day. So how do we use  

that? Well let's say the market was trading in  a half percent range daily but the VIX was 20.  

Something's out of whack there: either the  market has to start trading more volatility,  

or the VIX is too expensive and vice versa.  This is why it's important to understand guys  

the math behind what the VIX really means, not the  actual calculations of what goes into each strike  

and the long-winded algorithmic math. But the  math of what I presented on the screen. Here,  

here is a VIX frequently asked question page  that I'm just taking right from the CBOE.  

If I bring this in here, what I want to show you  is what you don't need to know - that's what you  

don't have to know. That's the the nuts and bolts  if you're really, if you really want you know.  

Our math geek statistician and you want to  get into that. You don't need to know that  

just like you don't need to know how the  black shoals option pricing model works.  

You need to know the inputs and what makes option  pricing move, but you don't need to know all the  

math behind it. But if you ever have time  and if you have interest the CBOE website  

really will give you an extensive, extensive  look into what the VIX means: its calculations,  

other volatility products that are out there. It's  actually a very, very excellent place to learn.  

So that is the VIX. I hope that wasn't  too confusing and made sense to you.  

Knowing how to use the VIX and trading options  is crucial to your option trading career. And if  

you have any questions at all please leave them  in the comments down below. I really hope you  

guys enjoyed the video and if you did please  like, comment, and subscribe to the channel  

for more content. New videos come out every  Monday and Thursday. Take care everyone!