VolDex®
AN IMPROVED MEASURE OF IMPLIED VOLATILITY
The Nations® VolDex® Index is an improved measure of option implied volatility. VolDex measures volatility the way practitioners do, by focusing on at-the-money options. This approach allows practitioners to fully understand the state of an option market by isolating regions of volatility skew.
VolDex is calculated using a closed-form solution and is comprised of the first in-the-money and first out-of-the-money options for the weekly expirations bracketing the moment precisely 30 days in the future.
By focusing on at-the-money options rather than all out-of-the-money options listed, VolDex, along the the other Nations indexes, makes it possible to deconstruct option skew and understand what important portions of the skew are doing in relation to each other.
Interpreting the Value of VolDex
The Nations VolDex Index calculates the implied volatility of at-the-money options, the most important options listed.
VolDex is calculated using a closed-form solution rather than the iterative method used by most measures of implied volatility. And since VolDex measures the implied volatility of precisely at-the-money options it is both understandable and intuitive unlike the variance swap methodology that combines all out-of-the-money options into a single index value.
That single index value is confusing and it obscures the impact of skew which is the tendency for options with different strike prices to display different implied volatilities.
The ability to Deconstruct Skew® allows for market participants to really understand what the option market is telling them and it begins with VolDex.
How Is VolDex Constructed?
The Nations VolDex Index measures the implied volatility of precisely at-the-money options with precisely 30 days to expiration (we also offer 7-day versions for those more interested in shorter-dated expirys or looming catalysts. We also calculate a 1-day version of VolDex for the S&P 500.
The options used in calculated VolDex, regardless of the underlying asset, include the first in-the-money and first out-of-the-money call and put options for the weekly expirations bracketing the moment precisely 30 days in the future. These option components are interpolated to generate a mathematically robust, closed-form measure of at-the-money, precisely 30 days to expiration, implied volatility.
In summary:
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- VolDex measures implied volatility for the most important options listed;
- It allows users to Deconstruct Skew – this is how you can really understand what an option market is saying;
- Makes it much easier to identify trading opportunities since important portions of the option skew are highlighted.
VolDex Basics
VolDex is a measure of expectations for market volatility over the next 30 calendar days Since at-the-money options pro-vide the clearest indication of market expectations, VolDex uses these options exclusively and VolDex is calculated directly using a closed-form solution.
Option practitioners focus their analysis on at-the-money volatility to understand the dynamics of any option market. VolDex provides the information and insight they need.
Other measures of implied volatility, notably VIX®, incorporate a large and variable number of options, many of which rarely trade and many of which are substantially out-of-the-money. This reduces the value of the resulting measure and generates misleading statistical noise created by phenomena like the distance between strike prices, number of strike prices listed, and option skew.
It is impossible to know what is driving changes in a volatility index if the index uses all the options listed in an expiration. Is the index moving because of at-the-money options? Is it because of deep out-of-the-money puts? Is it because of calls? While it is impossible to know, each of these scenarios tell investors and hedgers very different things.
Historical Results
How To Use VolDex
VolDex is a robust measure of at-the-money implied volatility so the current level of VolDex can be compared to historical levels to serve as a measure of fear (if VolDex is historically high) or greed (if VolDex is historically low) and as such, it can guide traders as they search for optimal option strategies.
VolDex can also be compared from one asset class to another to gauge market sentiment in different asset classes and to help structure relative value trades in the option space. /p>
Key Ways to Use VolDex in Trading
Market Sentiment Gauge
VolDex provides intuitive insight into overall market sentiment with special focus regarding immediate price movements or movement of a smaller magnitude.
Here you can see important metrics regarding the history of S&P VolDex although we calculate VolDex on a wide variety of assets and each will have its own, often very different history (subscribers can access this data, updated on a daily basis, here.
As a sentiment gauge, we would consider VolDex to be high when it’s above the 75th percentile of historic returns. We would consider it to be very high when it is above the 90th percentile of historic returns.
We would consider VolDex to be low if it is below its 25th percentile value, and we would consider it to be very low if it is below its 10th percentile level.
When coupled with our other indexes, VolDex can provide complete but nuanced insight into market sentiment and expectations for realized volatility during the next 30 days.
Lifetime and 52-week metrics are updated daily and those values are available to subscribers.
Timing Option Market Entries and Exits
Since VolDex measures sentiment it can be a useful indicator. Below you can see the subsequent 21 trading day return for the S&P 500 index when VolDex trades are certain levels.
VOLDEX CAN HELP TRADERS AND INVESTORS DO ALL OF THIS MORE EFFECTIVELY
Timing Underlying Market Entries and Exits
VolDex offer unique insight into the thinking of traders. Because of this it can help in timing underlying market entries and exits.
For example, in the S&P 500 (the underlying asset for all our S&P 500 indexes is SPY, the S&P 500 ETF), VolDex can help time market entry and exit for strategies using at-the-money options.
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