VSTOXX is a method of showing implied volatility across a basket of Eurozone stocks (Euro STOXX 50). The VSTOXX number provides a benchmark of market volatility in European markets.
What Is VSTOXX?
One certainty about markets is that there is always a level of uncertainty. One way in which markets have sought to mitigate this uncertainty is by measuring it; the hope being that the resulting figures can to some extent predict future market activity.
One such measure is market volatility. Put simply, when calculated, a volatility index aims to reflect how far the price of stock or an option will deviate from its average over a given period of time.
There are two main schools of calculating volatility: Historical volatility involves looking at the historical data of closing prices. Implied volatility, meanwhile, focuses on options prices. VSTOXX® is a method of reflecting implied volatility.
VSTOXX is the EURO STOXX 50 Volatility Index and is based on the real-time market prices of EURO STOXX 50 options. According to Eurex, the VSTOXX is the “benchmark of European volatility” – in much the same way that the VIX is the benchmark of the S&P 500 in America.
Despite being a volatility index, it’s important to note that the VSTOXX model doesn’t measure the implied volatility of at-the-money EURO STOXX 50 options; instead, it measures the implied variance across all options of a given time to expiry.
The EURO STOXX 50 is an index of fifty blue-chip super-sector leaders from the 12 Eurozone countries.
It is derived from the STOXX Global 1800 Index and operated by Deutsche Börse, of whom a subsidiary is Eurex Exchange.
Eurex is the third-largest derivatives exchange in the world in terms of contract volume and EURO STOXX 50 options contracts are one of their most traded products.
At any given time, the VSTOXX provides a total of 20 indices, divided into 12 main indices and 8 sub-indices.
The main indices are calculated to provide constant values for 30-360 days to expiry at 30 day intervals.
The sub-indices reflect the actual next 1 to 24 month expiries of EURO STOXX 50 options contracts at 1-6 month intervals.
The main VSTOXX Index value is based on 30 days to expiry.
This, like the other main indices is calculated by an algorithm which uses linear interpolation (also known as the weighted average) of the two nearest sub-indices.
The calculations for the VSTOXX sub-indices take into account all options available in the Eurex system.
All VSTOXX indices are calculated every five seconds between 09:15 and 17:30 CET.
The aim of the VSTOXX model is not just to provide traders with an indicator of market volatility, but also to make volatility tradable in itself.
The concept of volatility as an asset class – in which an options portfolio responds to changes in volatility rather than price – is becoming more popular, with consistent average daily volume (ADV) and a defined term structure.
Traders can purchase VSTOXX Options and Futures contracts of up to eight months.
Both have a contract value of €100 per index point of the underlying (the VSTOXX Index). These Options and Futures are a potentially useful tool for investors looking to diversify or hedge their portfolio against price drops in the equity market.
This is because VSTOXX typically displays a negative correlation to the EURO STOXX 50, meaning that the VSTOXX Index has a tendency to rise when all other asset classes are declining, thus making it a popular method of portfolio insurance.
A helpful tool for traders taking a view on European volatility is the V-VSTOXX Index, which is essentially the volatility index for the VSTOXX itself. The V-VSTOXX’s index ticks are calculated in much the same way as the VSTOXX, although there are some subtle differences, including the main indices covering fewer periods of time to maturity (30-210 days in 30 day intervals).
Pros And Cons Of V-STOXX
There are several advantages to using VSTOXX as an indication of near and long-term market volatility.
For a start, the methodology used to calculate the indices eliminates some undesirable effects: Because the main VSTOXX indices come from linear extrapolation of the relevant sub-indices, they are a weighted average that is free of a specific expiry date.
In other words, the main indexes are renewed every five seconds (during calculation hours) and do not expire. This works to cancel out strong volatility fluctuations that can occur close to a contract’s expiry.
The VSTOXX methodology also exploits the whole option strike spectrum, as opposed to focusing on near at-the-money strike prices as some other models do.