Volatility Index is a barometer of fear & greed in the markets or statistically called as Std. Deviation (movement of any random variable away from its mean).
Black Swan events (low frequency & high severity) like War, Epidemic, Financial crises or Natural disasters can create fat tail events, which are typically located many Std deviations away from its mean and creates high volatility in the markets.
There is generally negative correlation between indices and their VIX. As a VIX falls, the index rises. And when VIX rises, the index falls.
Formula to calculate VIX is as below:
VIX index helps investors gauge market sentiment based on its price. The price of VIX can guide your decision making on when to go long or short. As a general rule, when the price of VIX is:
0-15, this usually indicates optimism in the market and very low volatility.
15-25, VIX prices in this range indicate normal market environment.
25-30 Depicts that volatility is increasing and investor confidence is shaking.
30 and more — VIX prices over 30 typically indicate some extreme events in the market coming up.
Another way to interpret VIX is as below:
Say the VIX is presently 10. This means there is about a 68% probability (one standard deviation) that the absolute value of the market’s return will be 10/√12 = +-2.89 over the next 30 days (one month).