Question

5. Define the VIX index.

   1. What do you think is its relation with the development of the derivatives market?

   2. What kind of relationship the index may have with the real economy? Why?

   3. How would you relate the VIX with the Great Recession?

Answer 1

The VIX or CBOE VIX, was developd by the Chicago Board Options Exchange as a real-time market index to analyze the market's expectation of volatility in the next 30 days. Thus it basically observes the moves in prices of S&P 500 index options to gauge the market sentiments driving the price movemnt and thus undelying implied volatility in Index or in larger scale the volayility of market. Thus if the market is expecting some stress scenarios, the this will impact the derivatives markt and the option prices will show some erratic behaviour & moves. This will be captured in VIX. Thus VIX movements acts as a barometer of market risk, fear and stress due to which is it widely used by multiple market particpants & observes to analyze market risk & take investment decisions.

VIX which is essentially the implied vol in the market is used by traders to price the derivatives. This is because VIX gives an indication of what is the expected volatlity of stck which gives indication of what will be the expected price of stock. Traders can use this information to correctly price their option trades & decide if a particular option price to purchase a stock at a particular strike price make financial sense & is worth the risk return payoff.

More than an indicator of market sentiments, risks & stess, VIX is now also a tradeable asset now. Market participants can purchase the index or can trade in other VIX related derivatves products like VIX options, futures etc. Market participants like traders, institutional investors, mutual funds, investment banks, Insurance companies and hedge fund managers all trade in VIX securities in their portflio for multiple purposes like portfolio diversification and making active bets on volatility in market.

VIX is not the cause of recession but rather an indicator of upcoming recession. As defined above, VIX measures the risks, stress or volatility in the market which could be due to multiple reasons. The reason for VIX moves could be multiple. They could be long or short term reasons. Depending upon thes reasons, the VIX movement may be high for long or short term. When VIX movement is high due to some huge market concern like COVID 19, VIX movment can be a signal of upcoming recession.