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What is India VIX?
The Volatility Index (VIX) is a barometer of the market’s expectation of volatility over a short-term period. India VIX, also known as the Fear Gauge/Fear Index, is a volatility index computed based on the best bid-ask quotes of out-of-the-money near and mid-month NIFTY Options that are traded on the F&O segment of NSE. This index is managed by NSE Indices Limited, previously known as India Index Services & Products Limited.
India VIX is non-directional, i.e., it doesn’t indicate the direction that the market will go. It is an indicator of the expected market volatility over the next 30 calendar days. For instance, if the VIX value is 16, then it means the investors expect the prices to fluctuate in the range of +16% and -16% in the next 30 days. So, if the NIFTY levels are 16,000, then it implies a range of 13,440-18,560.
The India VIX value usually oscillates between the ranges of 15-35. Any value below 20, usually denotes low volatility and market stability. However, since November 2021, there have been a few instances of the India VIX levels having gone above 20, suggesting that we may have moved to a higher VIX regime. This is in part due to the increased retail participation in the options segment, which is highly responsive to short-term events.
The highest ever reading of 92.5 of the India VIX levels was recorded in November 2008 due to the Global Financial Crisis. This was followed by a reading of 87 in March 2020, due to the COVID situation. As a general thumb rule, the higher the India VIX value, the higher the expected volatility, and the higher the market risk.
How is India VIX Value Calculated?
The Nifty VIX values are computed up to 4 decimal places to enable the market participants to analyse the price impact due to minute changes in volatility. It requires data for the following four factors:
- Time to expiry: It is computed in minutes instead of days to arrive at a more precise value.
- Interest Rate: The model requires a risk-free interest rate which is usually equated to the NSE MIBOR rate for a particular tenure (say 30 days or 90 days) for the respective expiry months of the NIFTY option contracts.
- The forward index level: The latest available price of the NIFTY futures contract for the respective expiry month is taken as the forward index level. This forward index level is utilised for identifying the out-of-the-money (OTM) options that will be used for calculating India VIX. First, the forward index level will help determine the at-the-money (ATM) strike price. This strike price will then be used for selecting the out-of-the-money option contracts. NIFTY Call contracts with a strike price are higher than the ATM strike and NIFTY Put contracts with a strike price are lesser than the ATM strike and are identified as OTM options.
- Bid-Ask Quotes: The bid-ask quotes of the OTM option contracts, that were identified after determining the ATM strike price, which are just below the forward index level, are used for the calculation of India VIX. In case there are strike prices for which appropriate quotes are unavailable, then values can be determined through interpolation using “Natural Cubic Spline”, which is a statistical method of computation.
After identification of the quotes, variance (volatility squared) is calculated separately for both near and mid-month expiry. This variance is computed by providing weightage to each of the identified NIFTY option contracts, which is directly proportional to the average of bid-ask quotes of the options contract, and inversely proportional to its strike price.
These separately calculated variances for the near and mid-month expiry are then interpolated to arrive at a single variance value that has 30 days to expiration. The final India VIX value is the square root of this computed variance, further multiplied by 100.
History of the India VIX
India VIX was initially introduced by the Chicago Board of Options Exchange (CBOE) based on its S&P 100 Index option prices in 1993 and later revised to S&P 500 Index options in 2003. This methodology was adopted and adapted by the NSE as per the Indian market requirements and thus, India VIX was launched in 2008, followed by VIX Futures in 2014.
Significance of India VIX on the Stock Market
India VIX is considered a trusted indicator of market volatility and fluctuations. It helps different investors and traders in the following ways:
- Intraday traders: It provides key insights to intraday traders regarding the volatility shifts in the market. This assists them to assess the market risks with respect to equities. During high market volatility, intraday traders encounter the potential triggering of their stop-loss orders, prompting them to lower their leverage or expand their stop-loss boundaries. India VIX helps in making these important decisions by understanding market conditions.
- Long-term investors: Beyond intraday traders, long-term investors derive substantial benefits from this index. While they may not be greatly swayed by short-term volatility, they do face the risk of Margin-to-Market (MTM) loss restrictions. Therefore knowing the volatile index’s value can assist them in making an informed decision concerning their market investments.
- Options traders: The India VIX acts as a trustworthy indicator for opting to buy or sell an option based on the market’s volatile nature. In a highly volatile market scenario, option buyers take more advantage, while in less volatile market conditions, option sellers stand to gain the upper hand.
- Mutual fund and portfolio managers: Fluctuations in the VIX assist the mutual fund and portfolio managers in deciding the right time to invest in low-beta or high-beta stocks.
India VIX FAQs
You can invest in India VIX through the ways listed below:
- Derivatives Trading: Invest in India VIX derivatives for portfolio diversification and volatility trading. 3 weekly futures contracts are available for trading on NSE, which expire every Tuesday. The India VIX futures price is quoted as expected India VIX index value *100.
- Exchange-Traded Funds: Purchase ETFs linked to the volatility index.
Should you Invest in the India VIX index? Is the investment in India VIX safe?
Unlike price indexes, where retail participants invest for wealth generation, India VIX is more of a risk management tool. It is ideal for hedging portfolio risks and for vega trading by option writers.
What is the value/price of the India VIX index?
India VIX is usually priced within a median range of 15-35. The VIX values may have outliers and can also fall to zero, which would imply the index either doubling or becoming zero.
How is India VIX different from a price index, such as NIFTY?
NIFTY measures the direction of the price change in the market and is calculated by tracking the price movement of the underlying stocks, whereas India VIX is non-directional and measures the expected volatility by tracking the bid-ask quotes of OTM option contracts listed on NSE. NIFTY has an index value, while India VIX is denoted as an annualized percentage. NIFTY and India VIX are negatively correlated- when the VIX value is high, NIFTY falls, thus indicating a good time to buy stocks.
What is the objective of India VIX?
India VIX’s primary objective is to act as a market barometer. It indicates how volatile the markets are and how high the market risks are embedded in investment positions. It is representative of the market’s choppiness levels as it summarizes the price swings.
Who are the users of India VIX?
Investors track VIX levels to plan their trade in the following ways:
- Day Traders: In instances when the VIX value rises, they may run the risk of triggering their stop loss levels. Accordingly, they can make changes, to either reduce their leverage or increase their stop loss levels.
- Long-term investors: A higher India VIX level in the long term will imply increasing market uncertainties. In such cases, institutional investors can raise their hedge by going heavy on put option contracts.
- Options traders: Rise in volatility makes options more valuable to the buyers. They tend to buy straddles or strangles when market volatility rises or go heavy on futures on the VIX index.
- Fund Managers: Portfolio and fund managers invest in high beta portfolios when the India VIX levels are peaking and in low beta stocks when the VIX price is low.Contrarian investors: Such investors consider a low VIX level a bearish signal while a high VIX reading is a bullish signal.
What causes spikes in the India VIX?
Anything increasing investor uncertainty or risk aversion can lead to a spike in the India VIX. Several factors can cause spikes in the India VIX, including:
- Global economic uncertainty: When there is uncertainty about the global economy, investors tend to become more risk-averse, leading to increased volatility in the Indian stock market.
- Geopolitical events: Major geopolitical events, such as wars, political instability, or natural disasters, can also cause spikes in the India VIX as investors become more concerned about the potential impact on the global economy.
- Domestic economic factors: Domestic economic factors, such as rising inflation, interest rate changes, or weak economic growth, can also cause spikes in the India VIX as investors become more concerned about the future of the Indian economy.
- Stock market crashes: A sharp decline in the stock market can trigger a spike in the India VIX as investors become more fearful of further losses.
What does it signify when the India VIX decreases?
A decrease in the India VIX typically indicates that market participants expect less volatility in the coming period. This suggests that investors are more confident about the market’s outlook and believe that there is less risk of significant price swings. India VIX measures the expected volatility for the next 30 days in the Nifty 50.