For all the worry over its every little nuanced moves, the VIX is really just a number at heart, a derivative embedded in option prices for the S&P 500 index. But some interpret it as volatility that's actually expected in the future.
So if the VIX is 21 today, you might expect that a month from today, the actual realized one-month volatility of your S&P 500 ETF (SPY) would be around 21%.
Does this really work? Depends how you apply the data, I guess. But over the long term, it doesn't work any better than simply measuring today's actual realized volatility and using that as your guide for the future volatility.
This certainly isn't ground-breaking. The Wikipedia article on the VIX shows this analysis.
The chart at the right shows the relationship between today's realized one month volatility and future one month volatility. The chart at the left shows the relationship between today's VIX and future volatility.
The relationships were pretty much the same for the period covered in the charts, from 1990 to September, 2009.
I looked at a shorter time period -- from January 2009 to present -- and found a bit more differences.
The VIX seems to work better, but note something interesting. Actual realized volatility can easily dip below 10%. But does the VIX ever get that low? Hardly ever. Evidently, the VIX (and options traders) think it's a poor bet to assume volatility will stay that low, but sometimes they're wrong.
Single-stock VIX indexes: A look at the "Apple VIX"
I might study this in more detail in the future, but with are so many new VIX-like indexes available now, I thought I'd turn my attention to some of these other tools. Do they offer any predictive value at all?
The CBOE now provides an implied volatility index on several individual stocks, Apple (AAPL) among them.
Here's a chart showing the Apple VIX (VXAPL) vs. actual volatility as a predictive tool for estimating future volatility.
These blobs of pixels show there's very little predictive power here. Neither today's realized one month volatility nor Apple's single-stock VIX estimated future volatility well at all from 2009 until now.
Why? Think of it this way. Apple's implied volatility tpyically rises to high levels into earnings announcements, then falls off again. It happens quarter after quarter. The levels may change, but the cycle usually repeats.
Does that mean traders are stupid for paying high prices for options just before an earnings announcement? Not necessarily. You can buy high-volatility options and still make money when volatility falls -- or you can trade spreads where you both buy and sell options that can benefit from both rising and falling volatility.
So while the "regular" VIX is a decent tool at predicting future volatility, the Apple VIX doesn't serve this purpose well at all.
Sure, the Apple VIX may show whether today's option prices are expensive or cheap on any given day relative to previous days, but it doesn't tell whether they should have been expensive or cheap when next month finally does roll around.
Disclosure: I am long AAPL.