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Investors in the money market know that volatility can directly influence returns. To make informed decisions, it becomes important to measure how unstable or calm the market is at any given time. This is where a volatility index helps. India VIX serves as a market barometer, offering a clear view of expected market fluctuations.
Key Takeaways
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India VIX measures expected market volatility over the next 30 days, not price direction.
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A high VIX indicates fear and uncertainty, while a low VIX suggests stability and confidence.
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It is derived from Nifty 50 option prices using implied volatility.
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Traders and investors use India VIX to manage risk, plan strategies, and adjust market exposure.
India VIX Index Meaning
India VIX stands for the India Volatility Index. It measures the amount of volatility that traders expect over the next thirty days in the NSE index. Simply, it is a calculation of price swings investors expect in the market over important market news. When the value of the index is low, it indicates the absence of a fear factor in the market, meaning investors are more confident to invest. Conversely, a higher value indicates rising uncertainty and fear factors.
Although India VIX was introduced in the market in 2008, the volatility index originally appeared on the Chicago exchange in 1993. It helped gauge the presence of fear factors in the market. was introduced in the market in 2008, the volatility index originally appeared on the Chicago exchange in 1993. It helped gauge the presence of fear factors in the market.
What is India VIX in the Stock Market?
India VIX is the moniker used for the volatility index in NSE. It considers five variables for calculation: strike price, the market price of the stock, expiry date, risk-free returns, and volatility. VIX measures volatility expected by investors by taking into account the best bid and ask quotes of the out-of-the-money, present, and near-month NIFTY options contracts.
VIX and volatility move in the opposite direction. A higher VIX indicates higher volatility in the market, vis-à-vis a lower VIX, which means low volatility in NIFTY.
Let's understand with an example.
If the India VIX is at 15, it indicates an annualised volatility of around 15%. Under typical conditions, the NIFTY 50 might move (up or down) by about 4% over the next 30 days. This does not imply that prices will change by 15 points or 15%.
The India VIX does not have a defined range. Its value fluctuates according to market circumstances, rising substantially during uncertain periods and remaining low while markets are steady. Although the India VIX and NIFTY 50 frequently move in opposite directions, this relationship is not set in stone and may change over time. Simply put, the India VIX helps investors gauge whether the market is calm or worried in the short term.
Importance of India VIX Index
The India VIX index plays an important role in understanding market mood and risk levels. It helps investors gauge whether the market is calm or nervous before making trading decisions. A rising VIX signals uncertainty and sharp price movements, while a lower VIX indicates stability and investor confidence.
How is India VIX Calculated
The India VIX calculation is done using a model-free technique mandated by the National Stock Exchange (NSE), which is aligned with the CBOE VIX framework. It uses a weighted average of out-of-the-money NIFTY 50 options to forecast volatility over the next 30 days. Unlike implied volatility calculated from the Black-Scholes model, the India VIX is based only on market-traded option prices.
The India VIX is calculated as a weighted average of implied volatilities across many option strikes. The algorithm takes the best bid and ask prices from the NIFTY options order book and translates them into annualised volatility figures.
India VIX is mathematically represented as follows:
India VIX = 100 × √(Weighted variance of option prices)
The variance is determined by adding the squared implied volatility of chosen options, weighted by their separate contributions, and normalised using the total weight of the options evaluated.
Key Inputs for India VIX Calculation
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Time till expiry: To provide greater precision, option contracts' leftover expiry time is measured in minutes rather than days. A 30-day volatility estimate is based on near-term and next-term option expirations.
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Risk-free interest rate: The risk-free rate is calculated using government securities yields that correspond to the option expiration term, which commonly ranges between 30 and 90 days.
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Forward Index Level: The forward level of the NIFTY 50 is calculated using the most current available NIFTY futures price. This forward level is used to determine the at-the-money (ATM) strike price.
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Selection of Option Contracts
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Call options with strike prices higher than the ATM level.
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Put options have strike prices below the ATM level.
Only out-of-the-money option contracts are analysed because they accurately reflect market expectations of future volatility.
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Bid/Ask Prices: The best open bid and ask quotes for each option contract are used. If quotations for specific strikes are absent, values are calculated using a statistical interpolation approach known as a natural cubic spline.
Finally, volatility is computed separately for near-term and next-term expirations, then merged to generate a single 30-day annualised India VIX figure.
Factors to Consider While Calculating the India VIX
The India VIX measures anticipated volatility over the next 30 days but does not indicate market direction. The India VIX calculation considers the following major factors:
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Strike Prices: They are based on out-of-the-money NIFTY 50 call and put options, which accurately reflect market expectations of future volatility.
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Forward Index Level: The forward level of NIFTY 50, based on the most recent futures price, determines the at-the-money strike for option selection.
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Time to Expiry: Option contracts' remaining life is assessed in minutes, not days, for more accurate volatility assessment.
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Risk-Free Interest Rate: The risk-free interest rate is based on the yield of government securities throughout the option's expiry term.
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Bid-Ask Prices: Volatility inputs are based on the best available prices from the NIFTY options order book.
Planning Trade Around VIX
VIX measures near-term volatility for a period of 30 days. Hence, it uses options with the current month expiry and next month for calculation. It assumes that the option premium at the strike price of NIFTY is a reflection of the implied volatility of the overall market.
India VIX considers averaging the order book of NIFTY options as a good measure of market volatility. It uses a complex statistical formula, which you don't need to learn. But you must understand what it implies to plan trades.
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For day traders, India VIX offers a good measure of market risk. It gives traders an idea of when stock prices go up or down when market volatility changes. For example, when the VIX value rises, intraday traders run the risk of triggering their stop loss level. Accordingly, they can reduce their leverage or increase stop losses.
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Long-term investors don't bother about short-term volatility, but in the long run, rising India VIX gives a fair measure of increasing uncertainties when institutional investors can raise their hedge by going heavy on put options to play the market.
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Options traders depend heavily on the volatility metrics for buy and sell decisions. For instance, when volatility rises, options become more valuable and rewarding for buyers. Conversely, in times of low volatility, options tend to lose their value as they reach expiry.
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There are a few ways to trade volatility. Traders can buy straddles or strangles when market volatility rises. But this trading strategy is expensive. Hence, as an alternative, one can go heavy on futures on the VIX index without worrying about market direction.
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India VIX and NIFTY share a negative correlation. When plotted on a timeline of nine years since the inception of VIX, NIFTY reflected an opposite movement. Hence, when the VIX value is low, NIFTY rises and vis-à-vis. It gives investors a fair idea of market behaviour.
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When India VIX value peaks, portfolio and mutual fund managers increase their exposure in high Beta portfolios. Similarly, they would select low Beta stocks when the VIX value is low.
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India VIX is critical for options writers. High VIX value presents options writers with an opportunity for unlimited risk and limited rewards (premium). As the market passes through a phase of high volatility, out-of-the-money options contracts can turn into at-the-money or even in-the-money contracts in a matter of a few trading sessions.
Let's understand with an example how options writers use the VIX value while writing a contract. Suppose an options writer decides to write a contract for ₹275 for ABC stocks with a current price of ₹310. He plans to sell 3000 shares at ₹10 premium on a seven-day expiry contract. With the ongoing market volatility range, contract prices can fall to ₹230 in two days. Hence, his loss after five days will be.
Strike price ₹275
Spot price ₹230
Premium ₹10
He earns a loss of ₹(230+10) - ₹275 or ₹35. His total loss is ₹105,000 per lot. Hence, ideally, he will avoid writing the contract or charge a high premium if he does.
Conclusion
India VIX helps investors understand how nervous or calm the market may be in the near term. While it does not predict market direction, it offers useful signals about expected volatility and risk levels. Tracking India VIX alongside other indicators can support better trading and investment decisions.
Most importantly, it reminds investors to stay cautious, avoid emotional decisions, and be alert to risks such as a stock market scam during highly volatile phases.
