In 1993, the Chicago Board Options Exchange (CBOE) launched the Volatility Index (VIX), which became a crucial gauge for expected short-term market volatility. It serves as the foundation for trading volatility futures and portfolio hedging. Initially, the VIX was model-dependent and applied to the S&P100. Then, the CBOE developed a model-free VIX applied to the S&P500.
The majority of VIX research is centered around the S&P500 index. Reference [1] applied the same methodology developed for VIX but adapted it to individual liquid stocks. Specifically, it calculates 1-12 months VIX for Amazon, Apple, Goldman Sachs, Google, and IBM. The main findings are:
- The first important finding indicates that individual VIX indices exhibit a modest correlation with the aggregate VIX of the S&P 500, suggesting that much of the variation in individual stocks is firm specific. This finding holds true regardless of the maturity term.
- The second finding indicates that the VIX term structure of the individual stocks slopes upwards. The rise in VIX levels across various maturity periods for each stock could suggest that market participants anticipate volatility, potentially leading to fluctuations in individual stock prices.
- Third finding suggests that the variance risk premium is a promising indicator of where the security’s price is heading in the short run.
- Finally, given that the variance risk premium furnishes valuable information, we decompose its term structure and observe distinct pricing patterns for longer time horizons (see Figure 2). This result hints that investors seek greater compensation for the uncertainty surrounding the variance in returns in the distant future.
We find it interesting that the correlations between the VIX of individual stocks and the S&P 500 are rather weak, despite their similar structures and characteristics. This suggests that we can apply the same trading strategy developed for the S&P 500 to individual stocks and still achieve diversification.
Let us know what you think in the comments below or in the discussion forum.
References
[1] Mahmoud Qadan, Or David, Iyad Snunu b, Kerem Shuval, The VIX’s term structure of individual active stocks, Finance Research Letters Volume 61, March 2024, 105036
Further questions
What's your question? Ask it in the discussion forum
Have an answer to the questions below? Post it here or in the forum
Endeavour Mining plc (“the Company”) announces that on 23 December 2024, it received the following notification from Blackrock, Inc. of its interests in the Company as at 20 December 2024 TR-1: Standard form for notification of major holdings 1. Issuer Details ISIN GB00BL6K5J42Issuer Name ENDEAVOUR…
Read excerpts from columns that appeared in January, February and March 2024 in FP Comment
For commodities investors, ‘There’s a lot more to commodities than oil and gold,” says Calgary’s Auspice
Elon Musk's xAI, the startup behind the Grok chatbot and Colossus supercomputer, raised $6 billion in a Series C funding round.
The UK government is giving carmakers eight weeks to submit views on the phase-out of new gasoline and diesel cars, as ministers consider easing sales quotas that electric vehicle manufacturers are struggling to hit.
