The History of VIX.

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From Hamilton with modification.

 

 

The VIX is the implied volatility index for the S&P 500 but the VXO is the implied volatility index for the S&P 100 (the top 100 companies, 20%, of the SPX). 

 

Until September 2003, the VIX used to apply to the S&P 100 (OEX).  That month the CBOE changed it to track the broader S&P 500.  And not only did the VIX’s mission change, but a new formula was introduced for its calculation too.  It incorporates a broader range of option strike prices, with weightings increasing closer to at-the-money.  So today’s VIX is totally new since late 2003, not comparable with the last bear’s.

 

To preserve the true historical VIX, the CBOE renamed it the VXO.  Thus the VXO was battle-proven in the 2000-to-2002 bear (where it was called the VIX) while today’s bear is the first the new VIX has ever seen.  While the VIX and VXO parallel each other closely most of the time, the VXO has a proven track record.  It is too bad the CBOE couldn’t have named the new S&P 500 VIX something else instead.

 

And in bear markets, when fear surges, institutional traders rush to liquidate their biggest and most-liquid holdings to raise cash fast.  This is the elite S&P 100 companies.  As of the end of June, this top fifth of the S&P 500 accounted for 64.5% of its market capitalization.  This is a big majority, no doubt, but it still means over one-third of the new VIX will be driven by stocks outside of the base S&P 100.

 

At particularly ugly fear extremes, the VXO should decouple meaningfully from the VIX for a few days.  The VXO will go higher faster, offering better trading signals.  The top 20% of the SPX is just vastly more liquid in panic situations than the entire index.  Big traders will dump OEX companies first as they have much higher volumes and much larger market caps so fast selling will have less of a price impact on any individual trader’s realized prices on exit.

 

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