The Volatility Index by David C. Stendahl
David Stendahl explains the volatility index (VIX), which measures volatility based on the implied values of eight Standard & Poor's 100 (OEX) options from which the weighted volatility index is derived when combined.
The volatility index (VIX) is a measurement of the market's volatility. It specifically measures volatility
based on the implied values of eight Standard & Poor's 100 (OEX) options that when combined calculate
the weighted volatility index. The Chicago Board of Options Exchange (CBOE) has been using this index
for five years and has only recently made it publicly available.
In its basic form, the VIX can help to determine if OEX options are undervalued or overvalued. Nothing
frustrates an option trader more than accurately predicting the market's direction, only to lose money
buying an overvalued option. Even if the market moves in the trader's direction, he can still lose money if
the option was overvalued when purchased. The premium of the option declines in value simply due to
supply and demand factors. Unfortunately, many option traders spend more time analyzing the market's
direction than they do pricing the specific option. Time constraints and a lack of computer power make it
virtually impossible for the independent trader to price an option accurately.