Optical encoder is the important sensor used for length and angle measurement. A new type optical encoder:virtual absolute encoder has inherited the advantage of the two old traditional ones. The principle of virtual absolute encoder has been introduced. A practical coding algorithm was designed according to the characters of the slit disk. The code design of indexing track highest to 17 bits comes true with the aid of computer aided design(CAD). A method to decode was also developed,which can convert the binary cyclic code into binary natural code,and this method furnishes the further engineering practice with the theoretical foundation.