CBOE introduced VIX to measure the market’s expectation of 30-day volatility implied by at-the-money S&P 100 Index option prices. This was in 1993. Ten years later in 2003, CBOE with Goldman Sachs updated the VIX to reflect  a new way to measure expected volatility, one that continues to be widely used by financial theorists, risk managers and volatility traders. The new VIX is based on  S&P 500 Index and is estimated via averaging the weighted prices of SPX puts and calls over a wide range of strike prices. In 2004, CBOE introduced VIX futures and two years later, in 2006, CBOE launched VIX options. VIX options is touted to be the most successful new product in CBOE history. What’s the reason for its success ? Well, the most obvious one is that VIX futures and options act as hedge against volatility exposure.

In the Indian Markets, NSE disseminates the VIX index and has archive of prices since 2007. More recently in Feb 2014, NSE has launched VIX futures with maturity varying from 1 to 3 weeks.

When one tries to understand VIX, some of the question that come up are :

  • Why is VIX based on out of the money calls and put prices ?

  • How is the formula derived ?

  • What changes should be made for illiquid options, i.e. quotes are not present or spreads are wide ?

  • Are there any differences in VIX computation between CBOE and NSE ?

  • Given the near month and mid month option prices, Can one replicate the VIX quote disseminated  by NSE ?

I have tried answering a few of the above questions in the following document :

VIX computation - NSE