Protection remains costly

By Lawrence G. McMillan

The CBOE Volatility Index (VIX) is sometimes referred to as an indicator which measures the cost of protection. To understand the thinking behind this definition, consider that most portfolio managers using listed options to protect their portfolio either buy S&P 500 Index (SPX) puts or VIX calls. SPX put purchasing is still the more common method. When demand is high for SPX puts, the price of those puts is typically forced higher, increasing their implied volatility and thus usually increasing the price of VIX. Hence, in this sense, VIX is reflective of the higher demand (cost) of protecting a stock portfolio with SPX puts.

For the fourth month in a row, the settlement value of VIX was between 33 and 34. This is such a narrow range, that it almost appears to be a flat line on the chart in Figure 1. We know VIX did not just sit there all month and had wide fluctuations throughout the month only to settle right back where it started...

Click here to read the entire Futures in Volatility article from 11/28/11