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The Volatility Index (VIX)

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#1 Guru Dudette

Guru Dudette

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Posted 31 January 2007 - 11:21 AM

The Volatility Index (ticker symbol VIX)

The VIX a measurement used to depict fear and optimism in OEX options activity. When many traders become fearful, the VIX rises, and when complacency about the market dominates, the VIX falls. What does this mean? Well, as you may know, the vast majority of put/call buyers are wrong and have the tendency to lose money.

Traders can often make money is by "fading" the trading community at large. i.e., if they lose, you win by going against the grain. In this case, only the dead fish swim with the stream.

Often the use of Bollinger Bands are empliyed for the purpose of noting its position within the bands.The charts we use show the wide range of the VIX over time and also show how the bands help define the limits of overbought and oversold under various market conditions.

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With regard to stock prices and index levels, the VIX measures the change in price as a percentage without regard to direction. This means that a rise of 1% is equivalent to a 1% decline. Volatility expresses movement- in either direction. It is suggested that you look at the future volatility, because it is this that option pricing formulas need as an input in order to calculate the theoretical (and therefore estimated) value of an option.

Implied volatility is the volatility percentage that explains the current market price of an option; it is the common denominator of option prices. Just as p/e ratios allow comparisons of stock prices over a range of variables such as total earnings and number of shares outstanding, implied volatility enables comparison of options on different underlying instruments and comparison of the same option at different times.

Theoretical value of an option is a statistical concept, and traders should focus on relative value, not absolute value. The terms "overvalued" and "undervalued" describe a relationship between implied volatility and expected volatility. Two traders could differ in their opinion of the relative value of the same option if they have different market forecasts and trading styles.

"I'd rather be vaguely right than precisely wrong." J.M.Keynes