The volatility index produced by the Chicago Board Options Exchange, more commonly known as the VIX, shows that volatility in the markets is returning to a pre financial crisis level. The index, often referred to as the fear index, is a weighted mix of options prices. The higher the index the higher volatility in the markets is expected to be. As market volatility increases or expectations of market volatility increase options prices rise. This is due to an options price being a function of volatility in the underlying asset. If the underlying asset is expected to be more volatile the corresponding options contract has a higher probability of being in the money so the price is higher.
The index has fallen back below 25 and is now trading below its 50DMA. The current level is in the range at which the VIX was trading in the one and a half years prior to the collapse of Lehman’s. The recent turmoil seen over the past couple of months in the markets saw a severe spike, a mini 2008, but now it appears to be trending back down after this spike. Will this trend continue and volatility will return to a level between 10 and 20? Who knows, the trend would suggest that volatility is reducing but it may spend some more time in the 20 to 30 range before the markets truly calm down to pre crisis levels.
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