The Volatility Index is a measure of the market’s anticipation of near-term volatility. Volatility is defined as the “rate and magnitude of price movements” and is sometimes referred to as risk in finance. Based on the order book of the underlying index options, the Volatility Index is a measure of the amount by which an underlying Index is projected to change in the near future (calculated as annualized volatility, expressed in percentage e.g. 20%).

IMPORTANCE –

The National Stock Exchange (NSE) established the India VIX or India Volatility Index in 2008, followed by NVIX Futures in 2014. The mean reversion of the value is thought to be replicated by volatility indexes like VIX and India VIX, which fluctuate around a long-term variance.

India VIX is an indicator that measures investor perceptions of market volatility in India. It’s generated using a formula similar to CBOE’s, which incorporates the best bid-ask prices and projected volatility for the next 30 days, plus a few tweaks to fit and adapt the NIFTY options order book.

The value of the India VIX moves in lockstep with volatility. A higher India VIX number implies more volatility predictions, implying a large move in Nifty, while a lower value shows lower volatility expectations, implying a minor change.

Nifty and India VIX have a high negative connection. When the India VIX falls, the Nifty rises, and when the India VIX rises, the Nifty falls. According to historical data, the India VIX peaked just a few days before the Nifty hit its post-Lehman low.

WHAT DOES IT INDICATE ??

  • The VIX is a very excellent and sound indicator of risk in the markets for equities traders. It informs intraday and short-term stock traders on whether market volatility is increasing or decreasing. They’ll be able to adjust their plan accordingly. Intraday traders, for example, face the danger of stop losses being triggered rapidly when volatility is anticipated to spike dramatically. As a result, they can either lower their leverage or increase their stop losses.
  • For long-term investors, VIX is also a very useful indication. Long-term investors are usually unconcerned by short-term volatility. Risk and MTM loss restrictions apply to institutional investors and proprietary desks, on the other hand. They might raise their hedges in the form of options to play the market both ways when the VIX indicates increased volatility.
  • The VIX is also a helpful indicator for options traders. The choice to purchase or sell an option is usually made based on volatility. When volatility is expected to increase, options become more attractive, and buyers tend to profit more. When the VIX lowers, there will be more time value squandered, and option sellers will profit more.
  • It’s also good for trading volatility. If you expect the markets to become more volatile, buying straddles or strangles is a solid approach. These, on the other hand, become prohibitively expensive when volatility is projected to rise. A better approach is to purchase futures on the VIX index, which allows you to profit from volatility without worrying about market direction.
  • VIX is a very accurate and dependable indicator of index fluctuation. You can observe a definite negative link in the charts if you plot the VIX and the Nifty movement for the last 9 years since VIX’s debut. When the markets are bottoming out, the VIX tends to peak, and the VIX tends to peak when the markets are bottoming out. This is a valuable input for index trading.
  • The VIX is a great tool for portfolio managers and mutual fund managers. When the VIX has peaked, they may increase their exposure to high beta companies, and when the VIX has bottomed, they can add on to low beta stocks. India Although VIX is just around 9 years old, it has already established itself as a reliable instrument for assessing market risk and volatility.

CALCULATION –

The Black Scholes Model is used to perform the actual computation. It makes use of the following five essential variables:

  1. The strike price of the options contract,
  2. The market price of a stock,
  3. Time to expiry,
  4. Risk-free rate of return and
  5. Volatility.

VIX does not indicate the direction of movement; it just indicates the magnitude of movement. This implies that VIX does not tell you if the stock market will rise or fall; instead, it informs you how much it will rise or fall. India VIX, in a very juvenile sense, gives you the market’s general greed or fear perceptions over the following 30 days.

The India VIX is expressed as a percentage. To begin, a % format indicates it can’t be higher than 100 or lower than zero, which you already know because, as previously said, it only says quantum, not direction. Fun fact: If VIX is zero, NIFTY may potentially go to zero or double.

FOR INSTANCE-

Let’s suppose the VIX is 24.19 on July 2, 2020. This indicates that in the following month, they predict NIFTY will move at a rate of 24.19 percent. However, because we’re dealing with an open economy, the function of option pricing and the VIX index is somewhat entwined. When the NIFTY falls, the VIX rises, which is an inverse relationship since there is greater anticipation of upward movement because the market must now deviate back to the mean in order to expand. Similarly, if there is a large gap between the current spot price and the strike price for the future, VIX rises because to higher volatility. However, for current market participants, a higher VIX might result in a wider disparity.

The India VIX may be beneficial in both stock and options trading, but there are a few factors to keep in mind. First and foremost, it is an estimate; the data just represents what individuals believe will occur, and it is subject to change when fresh information and news become available. Second, it might indicate that the market may rise, but it also has the potential to fall.