The Chicago Board Options Exchange (CBOE) Call Option Index provides an estimate of the average value of standardized, six-month, at-the-money call options, expressed as a percentage of the price of the underlying stocks. The CBOE index does not attempt to eliminate the effects of changing interest rates and changes in the pattern and timing of dividends. The Gastineau-Madansky index, on the other hand, eliminates these effects and focuses on changes in the market’s expectation for the volatility of the underlying stocks.
One can gain some appreciation of the effect of interest rates and dividends on the CBOE index by looking at the level of and the net difference between the short-term interest rate and the average dividend yield. Since 1978, when short-term rates began to rise relative to dividend yields, the CBOE and the Gastineau-Madansky indexes have diverged materially. The high short-term rates of 1979 caused the CBOE index to exceed the levels that prevailed during most of 1977; the Gastineau-Madansky index, in contrast, showed that expected stock price volatility was at a historical low in the second quarter of 1979.
Most investors who use an option premium index in their analyses use it as a measure of expected or implied stock price volatility. But the CBOE Call Option Index is too dependent on the dividend-interest rate differential to be a meaningful indicator of the market’s expectations for future stock price volatility.