In this chapter, we looked at volatility derivatives and their uses by investors to diversify and hedge their risk in equity and credit portfolios. Since long-term investors in equity funds are exposed to downside risk, volatility can be used as a hedge for the tail risk and in replacement for the put options. In the United States, the CBOE VIX measures the short-term volatility implied by SPX option prices. In Europe, the VSTOXX Market Index is based on the market prices of a basket of OESX, and measures the implied market volatility over the next 30 days on the EURO STOXX 50 Index. Many people around the world use the VIX as a popular measurement tool for the stock market volatility over the next 30-day period. To help us better understand how the VIX Index is calculated, we looked at its components and at formulas used in determining its value.

To help us determine...