Vix Is a Measure of the Market\'s

¶ … VIX is a measure of the market's expectations for 30-day volatility, usually of a broad index like the S&P 500. The VIX is calculated using the prices of a variety of options on the index. The implied volatility of these options is used, and the VIX is sometimes referred to as a fear gauge and a measure of overall market risk (Investopedia, 2012).

There are two versions of the VIX. The first is for the S&P 500 and the second is for the S&P 100. The former is considered to be more representative of the broad market than the latter (Bail, no date). Options are priced, of course, with a mix of risk premium and time value. For market index options, that risk is assumed to simply be market risk. Therefore, options on that will contain a time value and a market risk premium. It is the latter that is used in the calculation of the VIX (Ibid).

In the functioning of a manufacturing company, there is little use for the VIX. The first reason is that the stock market is a poor proxy for the health of the economy -- just because traders think the market is going to be volatile over the next month does not indicate that orders are going to move in any direction. A manufacturing company should be able to find dozens of better predictors, and might actually benefit from talking to its customers, rather than relying on something like the VIX to forecast its sales. One thing the company's managers might do is track the correlation between the VIX and future orders, to identify any relationship that might exist. This can be done with any number of different economic indicators, so the firm has a sense of what numbers it needs to pay the most attention to.

For the most part, financial institutions and especially banks would be the most likely to benefit from knowing what the market expects from market volatility. Companies that are trading actively on the market, and where short-term volatility is relevant to their trading strategies, can probably find some benefit from the VIX.

The Michigan Consumer Sentiment Index is useful for market traders because it provides some sense of consumer sentiment in the market. While this can fluctuate, the index does often have broad-based trends and traders will look to these trends. Because the numbers are taken in aggregate, the use of such an index in trading has greater relevance than the use by a company that has a limited set of customers. If the consumer sentiment index means anything, it simply means to show a direction for U.S. retail sales. These businesses, along with their supply chains, are the most likely to be directly affected, not by the index, but by the underlying trend that the index illustrates.