Rob Hocking, SVP, Head of Product Innovation at CBOE, joins Cheddar News to break down how the VIX is calculated, what role the VIX plays in the options market, and how investors can use the VIX Index to manage risk.

Understanding the VIX Index and the Options Market

This segment is brought to you by CBO defining markets through innovation, technology and trading solutions. The Vix index is often called the fear indicator. So what should traders know about the Vix? Well, joining us now to discuss all things volatility and the Vix index is Rob Hawking S V P head of product innovation at Rob. Thank you so much for joining us this morning. Can you break down the Vix? How is it calculated? And how can it help investors understand market sentiment? Good morning. Thank you for having me, Chloe. So the Vix is a measure of the expected implied volatility of the S and P 500 over the next 30 days. So simply put it, how much is the market expected to move or the S and P exactly how much is that expected to move over the next 30 days? And so a few things to note, how is it calculated? First off, it uses SPX option, quotes observable bids and offers to calculate its value. So that is where many of the traders behind me stand ready to commit capital and use calls and puts calculate the Vix and determine its value So secondly, the vix is purely a forward looking indicator. So anything that's happened in the past doesn't factor into the calculation. It is merely every day looking at what is the next expected 30 days of implied volatility. And then lastly, it's important to tell investors that the Vix itself does not imply direction. It merely implies movement. What is the volatility over the next 30 days? So with that level of Vix call it 16 implies approximately a 1% move each day in the S and P 500. But once again, that's, that can be up, that can be down. It's important for investors to know it doesn't imply direction. Absolutely Robin. Thank you for that breakdown. So what role does the Vix index play in the options market? Particularly when it comes to options pricing and trading strategies, volatility is an important input into options pricing. You know, the greater the volatility, the higher the uncertainty and generally that translates to higher option pricing. So you can think of the market as a matrix of calls and puts that are overlaid on an underlying by a call. You're rooting for the stock to go up by a put, you're rooting for the stock to go down. And so all that in both cases, Each represent a different probability of a different outcome. So what is the probability that the S&P will be up 10% by the end of April? What's the probability that maybe the S&P is down 5% by the end of next week, options allow you to build a portfolio that really allows you to define that outcome. And so now the VIX represents the markets expectation for how much the S&P is going to move. So that's important as you're trying to define these outcomes and anticipate where the market is going to go. Having an indicator like that can be very valuable for investors. Speaking of Rob, what are some ways that investors can use the Vix index to manage risk in their portfolios. So the Vix itself is not directly tradable. So many investors use it as kind of an indicator for really determining that market movement in terms of absolute level. And the Vix the higher the implied volatility generally the wider distribution of returns. So with that generally comes with greater uncertainty around the markets. That's why many associate a high Vix level with market dislocations and greater uncertainty. So now as I mentioned, the Vix itself is not directly tradable. Therefore, when the market and investors are going to hedge implied volatility, many of them turn to the VICS futures and options market that is directly hedge. And traders often focus on macro events that can lead to intraday volatility. How can traders position with options? Well, I think it's important when we talk about intraday volatility to talk about the evolution of the SPX weekly options complex. So in 2005, we listed SPX weekly options that expired on Friday in 2016, we added Monday and Wednesday expiry and then just this past year, we rounded out the complex by adding Tuesday and Thursday expiry. So now with options that expire every day of the week, investors can really position around short term moves in the market and short term moves in volatility. And so this has really been represented and I think backed up by the fact of our recent volumes. So over the past 12 months, the spx volumes have increased roughly 60% showing demand for the products. So then you asked, how are they positioning? I think two of the strategies we see very commonly are, as I mentioned, the outright use of options for directional trades. So like I said, by a call, want the market to go up by a put, you want the market to go down, we're seeing a lot of that style of trading and then also we're seeing a lot of spread trading and in particular the selling of credit spread. So that's selling an option and then buying an option farther out of the market. In this case, your risk is defined and known, but yet you're able to capture the premium of selling that credit spread. And we're seeing that a lot of that is happening in the market today. And so really, we will continue to evolve the product mix and the product complex to suit investors needs. But we're really excited about what we've seen as of late Hawking and head of product innovation at CBO. Thank you so much for your time for that breakdown today to learn more about options trading visit CBO dot com.