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Volatility in financial markets describes the speed and magnitude of price fluctuations in financial instruments due to economic factors. The stock market, especially, is subject to high volatility.
Investors and traders commonly use measures like the VIX Index (Volatility Index) to determine market volatility and employ risk mitigation strategies accordingly.
What is India VIX?
The volatility Index or VIX Index measures anticipated market volatility over a given period. It delves into the intricacies of market fluctuations to anticipate price fluctuations in financial markets.
NIFTY VIX is India’s Volatility Index (India VIX) to assess market volatility for the upcoming 30 calendar days. It is a percentage defining the level of uncertainty and expected price fluctuations in the Indian financial market.
For example, India VIX level at 14, suggests 14% volatility for the next 30 calendar days.
How is India VIX calculated?
India VIX introduced by NSE in 2008, derives its computation logic from the Chicago Board Options Exchange (CBOE). It considers the implied volatility of NIFTY Options that derive their value from NIFTY 50. The calculations rely on the order book of the underlying index options.
Normally, India’s VIX ranges between 10-30. A higher VIX is an indicator of high uncertainty, while a lower VIX indicates lower potential market turbulence. Decreased VIX often suggests investor confidence in market stability.
Factors that impact India VIX
- Time to Expiry: The number of days remaining for options contracts to expire impacts price volatility leading to shifts in India’s VIX.
- Interest Rate: The risk-free interest rate reflects the cost of holding securities and impacts the prices of options. Hence, interest rate change affects the VIX.
- Forward Index level: The forward index level determines where the Nifty 50 Index is expected to be at the options’ expiry date. India VIX is calculated using OTM (OUT of Money) options which are determined using the forward index level.
- Bid-ask Price: The VIX arrives at the expected market volatility by considering the best or optimal bid and ask price of the OTM (present and near-month Nifty options). It reflects uncertainty and market liquidity contributes to the calculation of the India VIX. A wider spread indicates lower liquidity.
The India Vix Chart over the past years shows VIX was at unprecedented levels, at a peak of 90, during the outbreak of the COVID crisis (March-April 2020). Subsequently, it was relatively stable around the 20 mark (June-July 2020 onwards).
Understanding the significance and application of India VIX
- Risk Management: India VIX determines market risks and helps traders form risk mitigation strategies to deal with high volatility in securities.
- Forecasting Market Movements: Extreme spikes in VIX levels may signal significant market events or market reversals which helps traders decide about entering or exiting the market.
- Options Trading: Options traders can benefit from the India VIX as it indicates option pricing. While a lower VIX may result in lower option premiums, a higher VIX can lead to higher premiums.
- Portfolio Allocation: India VIX guides traders in portfolio allocation decisions and helps them rebalance when the risk exposure is high.
- Market Analysis: Financial analysts utilise the India VIX to analyse historical trends to understand stock volatility in different market conditions.
India VIX for investing
The India VIX shows volatility over the next 30 days in the Indian financial market. Therefore, investors with a long-term perspective are less affected by day-to-day swings in the India VIX.
However, if this index continues to go up over a long period, it indicates increasing uncertainty and can create opportunities for Deep Value Investors.
India VIX for trading
Option traders pay more attention to the changes in India VIX as options contracts become more lucrative with a rise in volatility.
Stock traders also find it useful as with rising volatility, prices can shift quite quickly and stop losses will be triggered soon. They can adjust their stop losses according to the volatility shift.
Investors and traders in Indian financial markets can benefit from India VIX as it provides a quantitative measure of market volatility and sentiment, helping them manage risks in the dynamic market environment.
India VIX is commonly called the fear index, as indicates the level of fear of investors towards the stock market. A high index value shows high fear, while a low value shows less fear and more confidence about the stock market.
VIX at 30 is high, indicating high levels of market fluctuations and uncertainty. This is generally a high-risk situation which some traders take benefit of. Others wait for the situation to stabilise until they can take the next position.
India VIX is similar to other stock market indices and cannot be bought directly. You can however trade in India VIX by investing in exchange-traded funds or mutual funds who offer India VIX. You can also enter into derivative contracts with India VIX as the underlier.
A low VIX suggests low fluctuations and high market stability. VIX does not suggest the direction of price movements but only suggests the degree of fluctuations. Some investors see this as unfavourable as it does not allow booking high profits.