The New VIX Isn’t Better Than the Old VIX

Wall Street has a new “fear gauge.” The Cboe Volatility Index—better known as the VIX—has often been looked at by investors as an indicator of sentiment within the stock market. 

When the VIX is high, it reflects investor fear; and when the VIX is low, it reflects investor complacency.  

Cboe Global Markets calculates the VIX based on prices for near-month S&P 500 index options. When stocks gyrate wildly, options contracts—which allow investors to buy or sell at predetermined prices—tend to cost more.  

The traditional VIX is based on the implied volatility of S&P 500 index options with 23 to 37 days until expiration. 

But does the VIX accurately reflect investor sentiment?  

On Monday after Silicon Valley Bank collapsed, the VIX spiked to 26.5—above the five-year average of 21.5—but not necessarily a level that screams fear. 

Some people believe the VIX isn’t as good of a sentiment barometer anymore now that so much options volume has gravitated to extremely short-term options contracts, particularly those that expire in less than a day.  

Forty percent of the S&P 500’s options volume was in these so-called zero-day options contracts in the third quarter of 2022, according to data from Bloomberg and Goldman Sachs.  

That’s where the Cboe 1-Day Volatility Index (VIX1D) comes in. Launched on Monday, the VIX1D is designed to measure the implied volatility of S&P 500 index options that expire in a day or less. 

That makes it much more responsive to current events.  

Based on backtested data, on the Monday after SVB collapsed, the VIX1D would have jumped to 40—a much scarier level than that reached by the traditional VIX. 

Still, just because the VIX1D is jumpier than its traditional counterpart doesn’t make it a better fear gauge.  

On April 24, the VIX1D fell to 9.6. If you looked at that, you would think it was all sunshine and rainbows in the stock market.  

Yet in reality, the S&P 500 is still in a bear market, though volatility has been pretty muted recently. It’s obvious that shorter-term options are going to react to near-term events more vigorously than longer-term options. 

There comes a point where an index can become too responsive to near-term events, negating its usefulness as a sentiment gauge. The traditional VIX is nice because, while it might take a few days to get off the ground, when it does, you know that there’s a meaningful catalyst impacting the markets.  

Currently, there are 13 ETFs tied to VIX futures trading in the U.S., including the ProShares Ultra VIX Short-Term Futures ETF (UVXY) and the iPath Series B S&P 500 VIX Short Term Futures ETN (VXX).  

Unless the Cboe comes out with futures on the VIX1D, it’s unlikely we’ll see an ETF tied to that index anytime soon.  

Follow Sumit Roy on Twitter @sumitroy2