The S&P/ASX 200 VIX Index, better known as A-VIX, projects the probable range of movement in the Australian equity markets, above and below their current level, in the immediate future. Specifically, A-VIX measures the implied volatility of the S&P/ASX 200 for the next 30 days. When implied volatility is high, the A-VIX level is high and the range of likely values is broad. When implied volatility is low, the A-VIX level is low and the range is narrow.
Since A-VIX reaches its highest levels when the stock market is most unsettled, the media tend to refer to A-VIX as a fear gauge. In the sense that A-VIX is a measure of sentiment—of worry in particular—the description is on the mark.
Implied volatility typically increases when markets are turbulent or the economy is faltering. In contrast, if stock prices are rising and no dramatic changes seem probable, A-VIX tends to fall or remain steady at the lower end of its scale. A-VIX, in other words, is negatively correlated with stock performance.
For example, in November 2008, as stock prices sank, A-VIX reached an all-time high of 66.72. In the summer of 2014, with stock prices high, A-VIX hovered around 12.
A-VIX measures implied volatility by averaging the weighted prices of a wide range of put and call options. When investors buy and sell options, the positions they take—either puts or calls—the prices they are willing to pay, and the strike prices they choose, all reflect how much and how quickly they think the underlying index level will move. In fact, that’s what volatility is: the pace and amount of change. A-VIX uses options prices rather than stock prices in its calculation because options prices reflect the volatility buyers and sellers expect. That’s what implied in implied volatility means.
The options used to calculate A-VIX are put and call options on the S&P/ASX 200. Because the index represents approximately 80% of the total market value of Australian equities, using S&P/ASX 200 options ensures that A-VIX represents a broad—and current—view on volatility. What’s more, A-VIX uses a specific combination of options that is designed to balance out all the other factors that generally affect option prices, resulting in an index that parallels volatility expectations alone.
The A-VIX time frame is significant. A-VIX anticipates moves in the S&P/ASX 200 specifically over the next 30 days. That is enough time for investors to make decisions and act on them, but close enough to add a note of urgency if significant change is forecast.
Investors may use A-VIX futures to diversify their portfolios, seeking to hedge portfolio risk without significantly reducing potential return. For example, when markets are unsettled, investors may allocate a small percentage of their capital to A-VIX futures, hoping to offset anticipated losses in their investment portfolios.
What makes A-VIX attractive in a diversification strategy is first its consistently negative correlation with equity securities: the more the market falls, the more volatility increases.
Second, A-VIX tends to rise more dramatically when markets fall significantly. For example, if equities, or the S&P/ASX 200, were to lose 50% of their value, A-VIX might be anticipated to increase several hundred percent. This characteristic of typically reacting more dramatically to a large equity loss than to a large equity gain is called convexity. Convexity means the investments associated with A-VIX may provide greater protection when it is needed most.
Volatility can be bought or sold. It works as a diversification tool. It can provide a positive return, although it pays no interest or dividends. But unlike most traditional asset classes, volatility is never a long-term investment.
The recurring up and down pattern of the market cycle may encourage investors to sell A-VIX futures following a weak period in equity markets. In this case, they anticipate equities will begin to gain value and the prices of volatility-linked products will decline. Alternatively, when A-VIX is low, investors may wish to buy A-VIX futures in anticipation of a future period of weakness. These similar trading strategies aim to exploit the historical tendency of A-VIX to revert to its mean after a period of increasingly higher or lower levels.
Investors may also seek arbitrage opportunities that result from mispricing of A-VIX futures. For example, they may sell individual options and take an opposite position in A-VIX futures, particularly if the implied volatilities of the individual options look expensive compared to A-VIX. Or, they may take opposite positions in A-VIX futures with different maturities. In some cases, for example, premiums on A-VIX futures may be higher or lower than realized volatility justifies, and exploiting this discrepancy may produce a profit.
Like other indices, A-VIX is expressed as a level, or number. Changes in the level, up or down, are expressed as percentages. But unlike other indices, whose results indicate market performance, the A-VIX level communicates a different type of information: the 30-day implied volatility of the S&P/ASX 200. Implied volatility, in turn, indicates the expected range of the S&P/ASX 200, above and below its current level, over the next 30 days.
The higher the A-VIX level on any given day, the higher the implied volatility and the wider the range of potential variation in the level of the S&P/ASX 200. For example, if the current level were 10—which is at the low end of historical readings—the deannualized 30-day implied volatility is 2.9%. This means in 30 days the S&P/ASX 200 is expected to trade between 2.9% lower and 2.9% higher than its current level. On the other hand, if the A-VIX level were 30, it would imply an expected level of the S&P/ASX 200 between 8.7% lower and 8.7% higher in 30 days.
A-VIX, or the annualized 30-day implied volatility of the S&P/ASX 200, is calculated throughout each trading day by averaging the weighted prices of a specific group of S&P/ASX 200 call and put options. As with other S&P DJI indices, the methodology used to calculate A-VIX is rigorous and transparent, though it differs from other indices in that it measures volatility rather than changes in security prices.
The A-VIX methodology specifies that the near-term (or, first month) and the next term (or, the second month) S&P/ASX 200 option contracts are used to calculate the index. When the near-term options have less than a week to expire, A-VIX calculation rolls to the second and third contract months.
ASX launched S&P/ASX 200 VIX futures on 21 October 2013. S&P/ASX 200 VIX futures enable market participants to trade anticipated changes in Australian equity market volatility in a single transaction. S&P/ASX 200 VIX futures are an ASX-listed product that enables trading participants to more easily hedge, trade and arbitrage anticipated volatility in the Australian equity market.
Data vendor codes for real-time S&P/ASX 200 VIX
The VIX® Network is an association of exchanges and index providers dedicated to establishing standards that help investors understand, measure, and manage volatility. The network’s members have obtained, from CBOE and S&P DJI, the rights to use the VIX methodology to calculate their own volatility indices.