Launched in March 2013, the real-time S&P/ASX 200 VIX® is designed to measure the expected 30-day volatility of the Australian benchmark equity index,the S&P/ASX 200. It uses the same methodology as the widely followed CBOE Volatility Index (VIX),which is designed to measure market expectations of near-term volatility embedded in S&P 500® options prices. Since its introduction in 1993, VIX has been viewed as the “investor fear gauge” for the equity market. In March 2004,the CBOE Futures Exchange (CFE) began trading futures on VIX,and this has become one of the most successful futures products traded on the CFE.Due to growing interest and demand from investors,the CFE extended trading hours for VIX futures in June 2014.[1]
The success of VIX derivatives is largely due to their potential ability to hedge against the U.S. equity market. Since VIX spot is derived from S&P 500 options prices and the equity options market is largely driven by market hedgers, VIX spot usually increases when investors rush to buy put options to protect their market exposure in a foreseeable bear market. By the same token, VIX spot tends to decline when investors have a more optimistic view and reduce their hedging. From Jan. 1, 2000, to June 29, 2018, the correlation between VIX spot and the S&P 500 was approximately -73%. Exhibit 1 shows a clear negative correlation between VIX and S&P 500 returns.
The negative correlation between VIX and the S&P 500 indicates that these two indices often move in opposite directions. Additionally, this negative correlation tends to be more pronounced in a stressed market than in a market rally. In other words, when the equity market declines sharply, VIX usually rises quickly; when the equity market rises, VIX generally declines slowly or hovers at a relatively low level. As a rule of thumb, high VIX levels are typically associated with a bear market.
Although market participants cannot trade VIX spot itself, they can use derivatives that track VIX, including futures and options. These derivatives may have different characteristics than the spot index, but they still maintain the potential hedging property of the spot index. Exhibit 2 shows the correlations among the S&P 500, VIX spot, and two VIX futures benchmark indices in the U.S.
