What's your view, would love to hear what some of you have to say in response to building volatility indices...........http://www.cboe.com/micro/vix/method.aspxDoes it serve any purpose in the market, what can you do with it?? Care to enlighten me?In what ways other than components of the index, is the CBOE VIX different or similar to the Fimat FVAM index?? Heard of other vol indices, tell me, tell me.......Thanks!!!!!!!!!!

The VIX index is supposedly the fair level of volatility which is calculated by using replication. Essentialy, given enough options, wide enough continuum of strikes, some continuity restrictions (simply a liquid option with a very well behaved underlying), you can theoreticaly replicate a static volatility payoff. There are some theoretical inconsistencies in the VIX methodology such as they use a liner approximation to interpolate fair level of volatility.... which is obviously wrong since the term structure is curved. They also take the sqrt of variance (which is obtained from the replication strategy)... which is wrong, since there should be a volatility of volatility adjustement. What the index is used for in practice i dont know, but simillar methodology is used to price variance and volatility swaps and forwards. These are used by banks and hedge funds to hedge and speculate on the future level of volatility. I see a lot of potential in this area, since any long possition is also long volatility and so certain adverse movements could be hdged away by using these instruments. Also notice that volatility increases in a bear market or in times of uncertainty and so it could be a hedge against adversity in general.