Volatility 101: What It Is, How It Works, and How to Use the VIX

Volatility Explained in One Minute: From Definition/Meaning & Examples to the Volatility Index (VIX)

Volatility is a term that describes how much the price of an asset, such as a stock, a bond, or a commodity, fluctuates over time. It is a measure of risk and uncertainty in the market, as well as a potential source of profit or loss for investors.

There are different ways to measure volatility, but one of the most common and popular ones is the CBOE Volatility Index, or VIX. The VIX is an index that tracks the expected volatility of the S&P 500, a benchmark index of the US stock market, over the next 30 days. It is calculated based on the prices of options contracts on the S&P 500, which are financial instruments that give the buyer the right to buy or sell the underlying asset at a specified price and date.

The VIX is often called the “fear index” or the “fear gauge” because it tends to rise when investors are nervous or pessimistic about the market, and fall when they are confident or optimistic. A high VIX indicates that the market expects large price movements in either direction, while a low VIX indicates that the market expects small price movements.

For example, on December 29, 2023, the VIX closed at 12.45, which means that the market expected the S&P 500 to move by about 12.45% in either direction over the next 30 days ¹. This was a relatively low level of volatility, reflecting the strong performance and stability of the US stock market in 2023. However, on March 16, 2020, the VIX reached an all-time high of 85.47, which means that the market expected the S&P 500 to move by about 85.47% in either direction over the next 30 days ². This was a very high level of volatility, reflecting the panic and uncertainty caused by the COVID-19 pandemic and its impact on the global economy.

Volatility is an important factor to consider when investing, as it affects the risk and return of different assets and strategies. Generally, investors demand a higher return for holding more volatile assets, as they face a higher chance of losing money. However, volatility can also create opportunities for investors who can take advantage of price fluctuations and diversify their portfolio.

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