Is the VIX a market indicator

The boiler-plate definition of the CBOE Volatility Index is “a measure of market expectations of near-term volatility conveyed by S&P 500 index options prices.” Informally, the VIX is known as the “fear gauge” because it tends to rise as the market falls. Formal or informal, however, doesn’t matter to most traders who simply want to know, “Does the VIX help me trade?” This article attempts to answer this question and others by examining the VIX’s oft-touted predictive abilities.

Types of volatility
Explained simply, volatility means movement. Explained mathematically, volatility is the standard deviation of daily returns converted to an annual percentage. Essentially, volatility describes the shape of the bell curve stock prices are assumed to follow. High volatility means large price changes are relatively more likely and low volatility means such price changes are less likely. But something is missing from these definitions.

There are at least three ways of thinking about movement. Historical volatility measures the actual past price movement in a market, but during what time period — the past 30 days, 90 days, one year? Future volatility (or realized volatility) is the movement between now and some future date, but that is impossible to know. Finally, implied volatility is the volatility number in an option pricing formula that justifies the market price of an option. Because option prices are determined by supply and demand, and because all inputs to the option-pricing formula are observable except volatility, then implied volatility is the “plug figure” that gives insight into what the market is thinking.