India VIX

For a long time, market participants have been trying to get a pulse of the market and the sentiments of market players. A volatility index, known as India VIX, serves this purpose. It helps investors look for bottoms, tops, and lulls in the trend while showing them whether the market is optimistic or fearful about the growth prospects. Continue reading to understand what exactly India VIX is, why it is considered an important indicator, and how to interpret its rises and falls.
 

India VIX is India’s volatility index. The value of India VIX on a particular trading day shows the market’s expectation of volatility in the next 30 days. India VIX was introduced in the country in 2003 by the National Stock Exchange (NSE), following in the footsteps of the Chicago Board Options Exchange. 

Generally, a volatility index measures the extent to which an underlying index is expected to fluctuate in the near term. It is calculated based on the order book of the underlying index’s options. In India, this index is the Nifty Option. So, India VIX measures both – the supply and demand for Nifty options and the put-call ratio.  

A higher value of India VIX indicates higher volatility and fear of negative growth among market participants and vice versa. Let’s understand this using an example. Let’s assume the value of India VIX is 20. This means traders are expecting 20% volatility in the next 30 days. To further boil it down, it means, within the next 30 days, traders expect the value of Nifty to range between +20% and -15% from its current value.

However, it is important to know that a volatility index is not similar to a price index like Nifty. While the price index takes the prices of individual equities into account, the volatility index considers the order book of the underlying index and represents the volatility in a percentage.
 

The stock market is dynamic, with indexes and stocks settling several percentage points higher or lower than the previous day. Sometimes though, the market undergoes dramatic price changes, and a measure of these price movements is called market volatility. 

It measures both the frequency and enormity of the price movements. Generally, the more frequently and larger these price movements occur, the more volatile the market is.

Mathematically, however, volatility is the statistical measure of the dispersion of market prices on an annualised basis. It is calculated as standard deviation multiplied by the square root of time.
 

India VIX helps day traders figure out whether the market at large is fearful or fairly complacent about the market in the short term. It helps them calculate risk. If the volatility is high, traders’ stop losses might get triggered, in which case they would want to lower leverage and expand the stop losses. 
 
While long-term traders are not affected by short-term volatility, it is easy to assume India VIX might not be important for this class of traders. However, they may face the risk of mark-to-market (MTM) loss restrictions. An MTM loss is incurred when a stock’s price declines from its original price and the current price changes significantly. So if they know the trends of India VIX, they might be quick to make the right decision about their portfolio. 

Options traders also benefit from India VIX. It tells these traders whether to buy or sell an option, considering the market volatility. If the volatility is high, option buyers may benefit; if it is low, the sellers benefit. 

India VIX can also help mutual fund managers and portfolio managers — it can help them decide when to invest in high or low-beta stocks to clock maximum profits.
 

The value of India VIX is derived using the Black and Scholes (B&S) model. Prices for options contracts are frequently calculated using this model. While this model is generally accurate, it makes some assumptions that may deviate the final result from the real-world result. It uses five variables for the calculation of India VIX: 

● Strike price
● The market price of the stock
● Expiry date
● Risk-free returns
● Volatility

With these variables, options sellers can set reasonable prices for the options they sell. For calculation, Nifty options’ 30 days bid-ask quotes are considered. These options are traded on NSE’s futures and options segment. 
 

India VIX rises and falls continuously, along with the fluctuations in the market. If India VIX falls, the market expects the volatility to rise in the short term. At this point, the value of India VIX would be higher or close to 30–35. 

And if India VIX is falling, the market at large is not so worried about rising volatility. And at this time, India VIX would sport values close to 15. 
 

Nifty is the underlying index on which India VIX’s values are based. India VIX considers the order book of Nifty options to predict the market’s volatility over 30 days. As per past trends, India VIX and Nifty are negatively correlated. This means when India VIX rises; the Nifty tends to fall and vice versa. 

This makes sense in theory – if India VIX is rising, the market expects high volatility in the next 30 days. High volatility indicates high risk, which makes traders weary of placing huge bets in the market, which results in falling Nifty prices. 
 

Analysts, investors, and fund managers consider India VIX to measure market stress when making investing decisions. It keeps the market participants in line by encouraging them to buy low and sell high. When VIX spikes, investors consider pursuing safer investment strategies to lower risk and vice versa. 
 

The normal range of India VIX is between 15–35. A value close to or less than 15 suggests low volatility, whereas a value close to or higher than 35 suggests high volatility. 
 

India VIX makes a good investment depending on your trading strategy. One strategy is to buy when India VIX is high and sell when it is low. However, this is risky and expensive. Another strategy can be investing heavily in the futures of India VIX. Another way to trade in VIX is by investing in volatility-based exchange-traded funds (ETFs). 
 

Everyone can use India VIX to make trading decisions, from day traders to long-term investors to option writers to portfolio and fund managers. 

As stated earlier, India VIX indicates the volatility of Nifty options. So India VIX spikes when there is an increased demand for puts, increasing the implied volatility. 
 

When India VIX goes down, it means the market at large is not expecting periods of high volatility. This means the fear is low, the market is stable, and it expects long-term growth. This is also the time when Nifty experiences a price rise.