Introducing the new Australian share volatility index

Are you interested in the expected volatility of the share market? Then get some VIX.

From tomorrow a new Australian equity volatility benchmark will be published by Standard & Poor’s (S&P) and the Australian Securities Exchange (ASX). The benchmark will be known as the S&P/ASX 200 VIX (ASX code: XVI).

If you are familiar with share market investing you will note the similarity to the VIX index published by the Chicago Board Options Exchange (CBOE). In fact the Australian index will use the same methodology (under licence of course).

You can learn more about the volatility index and download a fact sheet on the ASX website here.

Following are some key highlights from the information provided by S&P and the ASX. If you get lost in all of this it’s ok – you don’t need to know it to successfully create wealth.

What the VIX is

The index measures the expected volatility of the top 200 shares listed on the ASX. Since it is a forward looking index, in a way it is like trying to put science around a crystal ball.

Expected volatility is calculated using the settlement prices of call and put options, which are derived from expected future prices of the underlying share.

Using and interpreting the volatility index

In regards to using the index I like this quote in the media release from Richard Murphy, ASX General Manager, Equity Markets, who said:

“observers of the index will have insight into the degree of uncertainty among investors and their expectations regarding the magnitude of future movements in the local equity market.”

Also from the media release is this tip on how to interpret the index:

“A volatility index at a higher level generally implies a market expectation of large changes in the S&P/ASX 200 over the next 30 days, indicating that investor sentiment is uncertain. Conversely, a lower volatility index value generally implies a market expectation of little change, suggesting greater levels of investor confidence.”

Should you care about the volatility index?

The index looks forward 30 days so it is very short term. That really is only of interest to short term traders and anyone contemplating making a purchase or sale of a direct share during that period. If you are investing for the long term you can probably ignore it and focus on enjoying the other elements of your life.

Further the index is non-directional – volatility is both ways. You don’t know if investors expect the fluctuations to be mostly up or down. So you can’t really interpret from the index that the market will go up or down and therefore you should either buy now or wait, respectively.

So unless you actively trade direct shares you are better off concentrating your energies on other financial elements. (Unless you want to impress people at the next barbecue with comments about how fearful or not investors are.)