Volatility Index Helps Assess Risk, Allocate Assets

Wall Street’s measure of fear – the Volatility Index – fell last week as the stock market rallied over news of a probable resolution to Greece’s debt crisis and events boding well for the nation’s financial service industry.

A Federal Reserve decision to impose a higher-than expected cap on debit-card transactions boosted stocks for Visa and MasterCard. Bank of America stock rose on news the bank had agreed to an $8.5 billion settlement of claims of sales of troubled mortgages.

As the good news rolled in and the market rallied, the VIX dropped and, at a relatively tame 15.34 on Friday, seemed like a rollercoaster car at the end of a wild ride. Over the past year the VIX soared and plummeted to highs approaching 38 and lows just above 14.

“It’s been a rollercoaster of a ride for stocks, with the ‘fear index,’ or VIX having some wild days over the past year due to concerns about a U.S. slowdown, Greek debt, rising oil prices and Japan,” reports CCNMoney.

The VIX moves opposite to the markets, so a peak in fear tends to overlap a steep drop in the S&P. The index neared 30 in March as civil unrest in Africa threatened world oil supplies, and a devastating earthquake and tsunami disrupted manufacturing and markets in Japan. During the financial crisis of 2008 the VIX remained elevated for much of the year and topped 80.

“Since its introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility,” according to the CBOE, which trades the index. The index give minute-to-minute estimates of short-term volatility based on real-term S&S 500 Index option activity.

The VIX is used by investors and financial advisors to assess investment risk and allocate portfolio assets. Traders rely on the VIX, a contrarian indicator, to assess whether market sentiment is overly bullish or bearish.

The VIX was introduced in a paper by a professor at Duke University, the CBOE said. Trading of futures on the VIX Index began in 2004 and VIX options were launched in February 2006. VIX Binary Options and Mini-VIX futures were introduced in 2008 and 2009, respectively.