A tale of two indices

In 1993, the Chicago Board of Options Exchange (CBOE) introduced the CBOE Volatility Index. This index has become the de facto benchmark for stock market volatility. On September 22, 2003, the CBOE revamped the definition and calculation of the volatility index and back-calculated the new index to 1990 based on historical option prices. On March 26, 2004, the CBOE launched a new exchange, the Chicago Futures Exchange, and started trading futures on the new volatility index. Options on the new volatility index are also planned. This article describes the major differences between the old and the new volatility indexes, derives the theoretical underpinnings for the two indexes, and discusses the practical motivations behind the recent switch. It also looks at the historical behavior of the new volatility index and discusses the pricing of VIX futures and options.