OVX index: Your guide to the oil volatility index

Oil extraction
By :  ,  Financial Writer

What is the OVX?

The OVX, also known as the Cboe Crude Oil ETF Volatility Index, projects the market’s expectation of 30-day volatility for US crude oil. The OVX was first published in 2007 and has since become a convenient tool for traders to track and analyze the volatility of future oil prices.

The oil volatility index focuses on the implied volatility of options contracts on the United States Oil Fund, an ETF which tracks the price of West Texas Intermediate (WTI) crude oil future. Implied volatility is a measure of the market's expectations regarding future price fluctuations in the underlying asset, in this case, crude oil.

How does the OVX work?

The OVX works by tracking the price of USO options with near-term expiration dates. It does not track the price of WTI oil itself, but the price traders are willing to buy and sell WTI options at for the next 30 days.

According to Cboe, which runs the index, the OVX is calculated by “interpolating between two time-weights sums of option mid-quote values” for the United States Oil Fund (USO) ETF. “The two sums essentially represent the expected variance of the price of crude oil up to two option expiration dates that bracket a 30-day period of time.”

The level of expected volatility is plotted on a range from zero to 100. Similar to the VIX Index, the OVX is calculated in real time from 8 am to 2:15 am UTC and from 2:30 am to 9:15 pm UTC.

Interested in trading volatility? Check out our volatility trading guide and other index-specific guides like the MOVE Index, which measures bond market volatility, and the Gold Volatility Index (GVZ).

How to read the OVX

You can read the OVX like other market volatility indices such as the VIX. The OVX rises when investor fear is on the rise, and declines when fear goes down. However, increased fear usually drives oil prices upwards, unlike the VIX which has a negative correlation to the price of equities.

When investor fear comes down, there is a possibility that prices might begin to rise again. When analysing the OVX, it’s important to remember the index does not measure the price of oil contracts, just what oil traders and investors think about those prices.

How to trade OVX

The OVX can be integrated into several elements of your trading strategy, from implied volatility projections to risk management.

You can use the implied volatility of the OVX to forecast the likelihood of oil prices rising or falling. Volatility is a leading indicator, which means a rise in the OVX might precede a rise in US crude oil prices. You can find areas of support and resistance on the OVX and use them to guide your oil trading strategy.

However, similar to the VIX, the OVX often overpredicts 30-day future movements, because the oil market has time to react to volatility projections that are made a month in advance by the oil volatility index.

Additionally, you don’t need to trade oil to take advantage of the OVX. The OVX operates as an indicator of future oil prices, which correlate to other markets. Most US stocks along with USD have a negative correlation with the price of oil, as rising US crude oil costs lowers the expected rate of economic growth and increases inflation. On the other hand, commodity currencies may rise along with the price of oil, as do bond yields once the Fed reacts to rising inflation. 

Related tags: Insights Oil Volatility

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