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What is India VIX?
The Volatility Index, shortened to VIX, is a barometer of the market’s expectation of volatility over a short-term period. It 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.
India VIX, also known as the Fear Gauge/ Fear Index, is a volatility index computed on the basis of 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. India VIX 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 thirty days. So, if your NIFTY levels are 16,000, then it implies a range of 13,440-18,560.
The India VIX share price 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 at least five 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.
India VIX is non-directional, i.e., it doesn’t indicate the direction that the market will go. This index is managed by NSE Indices Limited, previously known as India Index Services & Products Limited.
How is India VIX Calculated?
but suitably amended using cubic splines, for easy application to the NIFTY options order book. The Nifty VIX values are computed up to 4 decimal places so as to enable the market participants to analyze 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 in order 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 utilized 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 strike price > ATM strike and NIFTY Put contracts with strike price < ATM strike 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 in order 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.
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.
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.
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.
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.
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.
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.