Gold's Own VIX "Fear Index"

Gold Prices just got their own version of the US stock market's VIX "fear index"...

TWENTY YEARS AGO, the research and marketing crews at the Chicago Board Options Exchange thought up the S&P Volatility Index – the VIX – writes Brad Zigler at Hard Assets Investor.

In creating the VIX, the CBOE thought they had a gold mine. Yet it's taken two decades to put gold into the VIX, and create a volatility index for precious metals traders.

The VIX uses near-term options prices to derive a volatility forecast for its underlying asset, the Standard & Poor's 500 Index. As volatility represents the degree of price variance around a mean, VIX is a measure of risk. When the VIX rises, in short, so too, do traders' expectations of wider price swings. That's why VIX got pinned with the title of "fear index".

There's money in fear. In fact, you could say that the CBOE is stirring up fear as it aggressively licenses its VIX methodology to other marketplaces. And now, the fear index methodology will now be applied to Comex Gold Futures. A new metric – officially dubbed the CBOE/COMEX Gold Volatility Index (GVX) – uses the same mathematical gizmos driving the VIX for the SPDR Gold Shares Trust (the world's largest Gold ETF, and a fair proxy for gold bullion prices).

The new GVX is actually part of a four-index suite including those tracking the volatility of futures on WTI crude oil, soybeans and corn trading on CME subsidiaries. Publication of GVX will commence with the October 18 trading session. The CME/Comex also plans to launch futures and options on the GVX by year's end.

So, why does gold – which some might say is a fear market itself – need its own fear index? Well, the VIX is forward looking. Embedded in option prices are volatility expectations for their underlying assets, but to get to them, you've got to strip away the other risk components – such as for price direction, interest-rate fluctuations and time 'til expiration. A VIX gives you a direct, real-time read on near-term volatility projections.

Whether any incremental trading information is obtainable via the new GVX isn't contained in the existing CBOE metric tracking GLD options is debatable. But, of course, that's not the point.

GVX will be the basis for new products. It's trading, after all, that makes money for exchanges. Still, volatility indexes are valuable in their own right. They give investors immediate insight into traders' thinking. Without volatility indexes like VIX or GVX, investors have to do more digging about to glean clues from the professional market.

Comparing the premia of out-of-the-money puts on the GLD trust shares and the SPDR Depository Receipts, for example, also gives investors a running commentary on the risk perceived in the gold market, but requires a little arithmetic.

And as it happens, up here at record-high Gold Prices, this "fear index" metric for gold – in essence, the insurance cost for gold positions – spiked higher late last week. Apparently, gold option traders weren't waiting for the new index, due to launch next Monday, to express their fear.
 
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