The India VIX is a volatility index. It is based on the NIFTY index option prices. The best bid and ask quotes of the out-of-the-money near- and mid-month NIFTY option contracts are used to calculate the India VIX. It shows the investor’s assessment of the short-term market volatility.
What is a Volatility Index?
The Volatility Index is a measure of the market’s estimate 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 likely to differ in the near future.
What is India VIX?
The NIFTY Index Option prices are the base for the India VIX volatility index. A volatility statistic (percent) is generated from the best bid-ask prices of NIFTY Options contracts. Hence, this indicates the predicted market volatility over the next 30 days. It employs the CBOE’s computing approach, with modifications to fit the NIFTY options order book, such as cubic splines.
The term “VIX” is a trademark of Chicago Board Options Exchange, Incorporated (“CBOE”). Standard & Poor’s has granted NSE a license to use the mark in the name of the India VIX and for purposes related to the India VIX, with permission from CBOE.
When the market is constantly moving and going up and down, the volatility index will rise. This shows the rise in market volatility. Similarly, when the market is more stable and volatility is lower the volatility index decreases. This indicator measures investors’ expectations for the market for the next 30 days or the near term. India VIX or volatile index, helps determine the market’s volatility, i.e., if it is increasing or decreasing. This helps investors better understand market conditions before making their next large investment.
How is India VIX Calculated?
India VIX Calculation Method
The Black and Scholes model, or B&S model as it is called, is used to calculate the VIX’s value. The strike price, stock market price, time to expiry, risk free rate, and volatility are all variables in this index. The bid-ask quotes of near and next month NIFTY options contracts traded on the NSE’s F&O sector determine the India VIX value. The value of the VIX has a direct relationship with volatility. This implies that the greater the value of the India VIX, the higher the volatility. The lower the value of the volatility index (VIX), the less volatile the market will be.
The VIX can assist market investors in better understanding the market’s volatility in the near future. Such an understanding can be useful before making any decisions on market investments in the future. A wide range of market participants, including investors, traders, options writers, portfolio, and mutual fund managers, use VIX. Furthermore, they alter their market expectations and beta exposure based on the VIX movement.
Elements of India VIX
VIX uses the CBOE’s technique and considers the following factors:
- Time to Expiry- The calculation of time to expiry is in minutes rather than days to meet the level of precision expected by traders.
- Interest Rate- The risk-free interest rate for the individual expiry months of the NIFTY option contracts is the tenure rate. This tenure rate is for 30 to 90 days.
- Forward Index Level- The out-of-the-money option contracts help determine the volatility index. The forward index level helps in identifying it. The forward index level aids in determining the at-the-money strike. The at-the-money strike aids in the selection of the options contract to be utilized in the computation. The forward index level uses the most recent accessible price of the NIFTY future contract for the respective expiry.
- Bid-Ask- The ATM strike is the strike price of a NIFTY option contract available right below the forward index level. NIFTY option Call contracts with a strike price above the ATM strike and NIFTY option Put contracts with a strike price below the ATM strike are out-of-the-money options. VIX uses the best bid and ask quotes of such option contracts in its calculation. Values are interpolated using a statistical procedure known as “Natural Cubic Spline”. Hence, this procedure is helpful when the strikes for which adequate quotations are not available.
- The variance (volatility squared) is estimated independently for near and mid month expiry after the quotes have been identified. The difference is calculated using the CBOE approach. This involves assigning weightage to each of the NIFTY option contracts used in the calculation. The weightage of a single option contract is proportional to the average of the option contract’s best bid-ask bids. It is inversely proportional to the strike price of the option contract.
Importance of India VIX in The Indian Stock Market
- The VIX is a valuable sign for options traders. The choice to buy or sell an option is usually on the basis of volatility. With high volatility, options become more valuable, and buyers tend to gain more. When the VIX falls, there will be more misallocation of time value, and option sellers will benefit more.
- VIX is a dependable indicator of index change. You can find a clear negative link in the charts if you plot the VIX and the Nifty movement for the last 9 years (since VIX’s introduction).
- For portfolio managers as well as mutual fund managers, the VIX is a priceless instrument. When the VIX has peaked, they can increase their exposure to high beta stocks, and when the VIX has bottomed, they can add on to low beta stocks.
Frequently Asked Questions
Market volatility for any investment is the rise or fall in the prices of investment products in a specified period. It is a common misconception that market volatility means only a fall in prices. However, market volatility reflects a price rise as well as a price fall. The factors that impact market volatility are political, economic, industry, company performance, and environmental aspects.
India VIX is a strong indicator of risk in the market. It provides insight to intraday traders and short-term traders into whether market volatility is increasing or decreasing. Mutual fund managers and portfolio managers both benefit greatly from India VIX. When India VIX is at its peak, they can try to expand exposure to high beta portfolios. When the VIX is at its bottom, they can add low beta companies.
India VIX does not affect stock prices directly. However, India VIX is an indicator of market volatility.
Since Nifty VIX is an index there is no direct way of investing in it. However, investors can invest in exchange traded funds that follow or track this index.
India VIX moves in the range of 15 points to 35 points. Hence any value that is below 35 points would suggest a poor value or volatility.
A high India VIX means high volatility or high fluctuations in the market.
A rise in India VIX means high volatility and fluctuation in the market. While a low India VIX suggests stability in the market.
India VIX is a volatility measure, whereas Nifty is a market index. Further, volatility indices like the India VIX indicate market volatility. Nifty and India VIX have a high negative correlation. The Nifty rises when the India VIX decreases, and vice versa.